Act now to manage your tax liability
“Lower crop and livestock prices mean earnings will be down,” said Joe Koenen, an agricultural business specialist for the Northeast region of the University of Missouri’s Extension Service. “Start gathering records now so you can estimate your taxable income for 2016.
If your income is greatly reduced, the easiest way to defer income is to hold on to crops or livestock and sell them in 2017.”
If you already postponed sales from 2015 to 2016, then holding onto this year’s crops or livestock until 2017 may not work. Income averaging might present another solution—this allows you to spread your income over this year and the last three years.
Koenen, who works out of Unionville, Missouri, says that farmers have more flexibility to control tax liabilities than other types of businesses.
You should make most decisions affecting your 2016 tax bite before year-end. We asked Koenen how you can prepare now for your 2016 taxes, and what to expect.
Can I sell crops or livestock in 2016 and take payment in 2017?
Yes, if you’re a cash-basis taxpayer, and you have a written contract with a particular stipulation, such as you won’t receive payment before 2017. But there’s a danger—what if the buyer’s business folds before you get paid?
What about crop insurance payments?
They count as income. If you receive crop insurance payments and typically sell that crop in the year following harvest, then you can defer non-price-related crop insurance payments into next year, but you must prove it’s your normal business practice. Also, you must report that it does not impact any government disaster payments occuring in a previous year but received in the current year—those payments must be declared this year.
What records do I need to gather now?
Pull together documents related to income and expenses as well as purchases and sales of depreciable assets such as machinery and breeding livestock. Include loan information, as you can deduct interest paid on farm business loans.
Should I purchase equipment before year-end?
Typically farmers purchase equipment in good times. I see fewer purchases this year and expect the same for a couple of years to come. That said, you should consider replacing equipment when you need it—when repair costs grow larger than payments would be for new equipment.
Are there any big changes in tax law?
For farmers, the limit of $500,000 on depreciation allowed under Section 179 of the federal tax law was made permanent—as long as Congress keeps it that way. Also, the bonus first-year depreciation was lowered from the current 50 percent for 2015 through 2017, to 40 percent in 2018 and 30 percent in 2019. Depreciation on farm buildings such as hay barns or machine sheds isn’t allowed under Section 179, but you can use the bonus depreciation.
What about employee expenses such as health insurance?
You can deduct reasonable wages, along with health and other benefit expenses you provide to your workers, but you must withhold Social Security, Medicare and income taxes from their wages. If you employ fewer than 50 people, you do not have to provide employee health insurance coverage. However, if you insure yourself or your family, you may have to cover employees. The rules are complicated, and you should see a professional. I won’t predict the election or changes that may result, but I think the Affordable Care Act is here to stay in some form or another.
Should farmers seek professional tax help?
Taxes are complex, and business taxes for farms are even more so. You need professional help, just as you do for legal and financial issues. It’s cost-effective and brings peace of mind.
What tax changes do you expect down the road?
I don’t anticipate major changes, but who knows what Congress may do? In the future, the IRS may have to clarify rules on equipment repair expenses, which many people don’t understand. Our current financial downturn could affect some producers as well.
How can I make the process easier?
It’s best to keep records up to date on an ongoing basis so you don’t fall behind. Since most farmers log financial records on a computer, it’s easier to do than in the past.
What’s your top advice?
You are responsible for the accuracy of your taxes, so you need to know the laws. Keep up with rules and regulations by taking classes from University Extension and by reviewing the IRS Farmer’s Tax Guide, Publication 225, which you can find online. Don’t cheat—penalties get worse every year!
Paul Neiffer, a CPA and a principal at the agribusiness practice of CliftonLarsonAllen in Yakima, Washington, offers these suggestions as you prepare your 2016 taxes.
- Work up a tax plan before year-end. Summarize your income and cash expenses, calculate depreciation and see what your tax situation looks like. Review the results with your tax adviser to determine if you need to prepay farm expenses or defer income.
- Pay your children for working on the farm. If the child is under age 18, this tax deduction is not subject to payroll taxes, assuming you file a Schedule F or husband/wife partnership. Your child might consider investing the earnings in a Roth IRA, which defers income taxes on the earnings.
- Pay employees with grain or other commodities. These wages are not subject to payroll taxes, which could benefit you and your employees. However, employees need to understand how this works.
- Set up a retirement plan. Farmers who invest in a retirement plan throughout their career have a much easier time of transitioning their operation to their successors than if they simply rely on land rents.
- Take advantage of a fuel tax credit. Review your fuel records to see if you qualify for a fuel tax credit on your tax return. Dyed diesel does not qualify, but other purchases may. For example, if you drive your pickup on the farm a lot, those gallons used qualify.
- Take advantage of deferred payment contracts. This allows you to sell grain this year and record income next year if that’s when you receive the cash. However, if your income looks to be too low, you can report the income in the current year on a contract-by-contract basis.
- Make grain gifts to a charity. This reduces your taxable income, and you do not need to report the gift on your tax return. If you are self-employed, it reduces your self-employment tax as well.
- Make sure you pay enough tax. Many farmers want to pay zero taxes. However, consider “soaking,” which means paying at least some tax—say up to the 15 percent bracket. If not, you face paying a tax rate of 35 percent or more when you retire. Keep in mind, working capital that has been taxed is yours. If it hasn’t been taxed, then it could belong to the bank or the IRS.
These articles provide general suggestions, but you must follow specific IRS rules to avoid penalties. Consult a professional tax preparer for advice on your situation.
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