INDUSTRY INSIGHTS | WINTER 2011/2012 EFFECT

Farmers: Know Your
Tax Options at Year-End

by Cheryl Meyer

Year-end tax planning helps you reflect, reorganize, and properly prepare for the coming year. It’s your chance to target your taxable income at the best level for you—whether that’s the top 15 percent tax bracket, the 28 percent bracket, or something else. If income is too high, there are some allowable strategies to reduce it. The flip is true if income is too low. Here are some things to consider as the year winds down.

Depreciation

For 2011 tax returns, the most you can deduct on purchases is $500,000, provided that your asset additions don’t exceed $2 million. This accelerated depreciation (Section 179) is allowed on eligible active business assets (e.g., new or used equipment, tile, bins, and irrigation systems for your farm). Machine sheds and shops don’t qualify. In 2012, the Section 179 limit drops to $139,000.

The 100 percent bonus depreciation is allowed on qualified new property, such as a farm machine shed or shop, placed in service before December 31, 2011. If the asset is placed into service between January 1 and December 31, 2012, the bonus depreciation drops to 50 percent. Landlords also can use this accelerated depreciation.

Remember, assets are depreciable only when they are available to use. If you are already paying for a piece of equipment that won’t be delivered until the spring of 2012, you cannot deduct it in your 2011 tax return. By planning before year end, there may be a tax savings if you buy that tractor yet in 2011, rather than waiting until 2012.

Prepaid expenses

While you are only eligible for the bonus depreciation when your asset is put into service, those restrictions don’t apply to all expenses. Expenses you will use or consume next year are deductible when paid. For example, you can buy seed for planting next spring and deduct it on this year’s taxes (and take advantage of lower prices). To qualify, the expense:

• Must be a purchase (not just a deposit)
• Must have a business purpose (price rise, scarcity, discounts)
• Should generally be consumed or used within the next 12 months
• Can be any type of expense, except interest

Deferred sales

Cash method farmers can sell their inventory and defer the income to the next tax year. This allows you to sell the commodity and secure the desired sale price, but recognize the income next year. Here are some important things to know:

• You must have a written contract at delivery or sale that restricts payment until the designated date.
• Interest on the contract is acceptable.
• If you are selling a commodity, such as purchased feeder pigs or cattle, the cost of the commodities sold isn’t deductible until the income is recognized.

Consider multiple smaller contracts. This allows income adjustment during tax preparation, by electing out of the installment sale reporting method on a contract-by-contract basis. If you have one deferred contract for $100,000, you either have to report the entire amount this year or next year. If you have five contracts for $20,000 each, the decision can be made independently on one or more contracts to get to the desired amount.

Farm income averaging

If this is a higher than normal income year, income averaging may be beneficial to reduce the effective tax rate. Your taxable income for the last three years is used in this computation, with the hope of hitting unused lower tax brackets.

Social Security

For 2011, the self-employed Social Security tax is 13.3 percent of the first $106,800. After that, Medicare tax of 2.9 percent is paid on the excess. So think of it this way: even if your income ends up in a higher bracket, you may end up with tax savings because you’ve maxed out on Social Security.

Other considerations

High-income earners:

• Set up an individual retirement account (IRA) or simplified employee pension (SEP). If you’re debating one of these options for 2012, remember they can be established and funded after year-end, but payment isn’t required until April 15, 2012. Consider retirement options for eligible employees as well.
• Since most farmers don’t itemize, you can also explore if you’d benefit from prepaying state income tax before December 31, to forgo the standard deduction.

Low-income earners:

• Slow down depreciation expenses and delay asset purchases until 2012 if next year’s income is expected to be higher.
• Roll over an IRA to a Roth IRA. This could minimize the tax on this rollover and provide future tax benefits of a Roth IRA.
• Withdraw funds from an annuity. The income earned on the annuity is taxable when taken out, but beware of an IRS-imposed 10 percent early withdrawal penalty on the income if you are under age 59 ½.

When it comes to tax strategies, each year is different. Proper planning is important to take advantage of opportunities and avoid pitfalls for yourself and your business.