Dried herbs! Delicious jams and cheeses! Zucchini bread! Value-added products are enjoyable to produce and can increase farm profitability. But since there is no single source of law and regulation for these activities, farmers are left to search in different places for answers. Here are some answers to common questions about the legal mechanics of altering farm products beyond their harvested state.
My farm operation is allowed under my local zoning ordinance. Does that mean value-added production is allowed as well?
The short answer is no, not necessarily. Even where a farm operation is allowed, zoning ordinances can prohibit value-added processing and direct-to-consumer sales on farms. This is because these activities may be classified as non-agricultural use of the property. Instead, these activities may be defined as commercial or retail in nature, and commercial or retail activities may be prohibited in agricultural zones (as well as in residential zones).
To find out if such activities are allowed, you will have to learn the zoning rules that apply to your location. One way to do this is to call the local zoning authority (which may be a city, town, or other local unit of government) and ask about the specific venture or project you want to undertake. Assuming you are in an agricultural zone, you can also ask whether allowed agricultural activities include some processing. Other farmers may prefer to research the zoning rules themselves. Many local entities have maps and ordinances online. Generally, a farmer will first research which code the farm location falls within on a zoning map. Then, the farmer will consult the ordinance to learn which activities are allowed or prohibited within that code. You can also talk with a local attorney, or a reference librarian, for assistance in understanding your zoning code.
Restrictive zoning rules can be changed via petition or by requesting individual variances which are one-time exemptions from the rules granted to a specific person.
Does value-added production change the way I do tax reporting and accounting?
Yes, value-added production and sales activities are handled differently than agricultural production and sales activities with respect to federal taxes. Income and expenses from a value-added enterprise are generally reported on Schedule C, Profit or Loss from Business, rather than on Schedule F.
This is different from the tax requirements for income and losses from farm production (which are reported on Schedule F). As the IRS defines it, farming activities include growing and harvesting crops, raising livestock or poultry, and preparing unmanufactured farm products for market and delivery to market. Any processing of a farm product beyond washing, handling, packing, grading, or storing (basically, beyond the minimum required for sale) will be classified as non-farming and is reported on Schedule C.
Do I need to collect sales tax on sales of my value-added products?
In most states, the food items a farmer makes, including value-added products, are not subject to sales tax. In 31 states, groceries (including farm products sold directly to the consumer) are exempt from sales taxation, which means both raw agricultural products and value-added agricultural products are not subject to sales tax. But foods sold ready-to-eat, like prepared sandwiches, may not fall under your state’s grocery exemptions, making them subject to sales tax.
A quick call to the state taxing authority should be enough to determine whether you must collect and pay sales taxes on products sold from your value-added operation. Also, most states publish easily understood guides that outline how sales tax applies to food items.
Am I liable if my value-added products make someone sick?
Despite taking the best precautions available, sometimes accidents happen. If someone is injured or sickened from products you made, you can be liable for the injured person’s medical bills and other damages.
The most efficient way to manage legal liability is to make sure your business has insurance coverage and to follow the terms of the insurance policy. Under a good policy, the insurance company will provide an attorney to defend the farm. This insurance coverage is valuable even for the safest farms, since even if you’ve done nothing wrong, you’ll still have to prove that in court if you are sued.
Beyond liability coverage, you might also consider seeking a commercial insurance policy that pays some costs of a recall, should one be necessary. Commercial policies may also cover lost income and remediation costs, which are not provided in standard farm liability policies. Availability and cost for these policies vary widely. You’ll need to think about what will give you the most cost-effective protection. Asking other farmers and home-based producers in your area about what coverage they have may be very helpful in discovering your insurance options.
DISCLAIMER: This guide does not provide legal advice or establish an attorney-client relationship between the reader and author. Consult an attorney for advice specific to your situation and the state in which you operate.