This isn’t the first time we’ve written an article this time of the year talking about finishing off the year knowing where you’re at from a financial perspective. The years come and go, and things that our farmers are facing are ever changing – good crops, bad crops, good commodity prices, bad commodity prices. As a result, some of you have had excellent years and some of you are facing more difficult years, and although you can’t change that, it’s always good to control what you can control.
As we get close to the end of the year, many of you start thinking about how to minimize your tax liabilities. Tax planning is the steps taken to minimize tax liabilities to ensure all available allowances, deductions, exclusions and exemptions are working together in the most tax-efficient manner and to reduce the total income tax paid to an amount a customer is anticipating.
Most importantly though – effective tax planning helps customers avoid surprises come tax season. Effective tax planning helps businesses achieve their financial goals and plan for their upcoming needs – it should lower taxable income, reduce tax rates, provide for greater control of when taxes get paid, and maximize deductions and credits whenever possible.
FARMERS’ RESPONSIBILITIES
First – what can you control? You need to be totally transparent with your tax accountant in the process and communicate your financial goals. Remember, your tax accountant is not a magician. Here’s a few accounting best practice tips that will help come tax planning time:
- Get your records in order: Having an accurate set of financial records is critical for a tax preparer to work with - this doesn’t mean a shoebox with a bunch of receipts. A computer program or a worksheet that reconciles back to your bank statements and debts should be completed, at a minimum. If you don’t have that set up and do not have the interest or ability, consider getting help with your bookkeeping. It’s part of the operation that can’t be ignored!
- Don’t procrastinate: Waiting until the last minute to get your records in order is a big no-no. Waiting until late in December to start your bookkeeping for the year leaves you scrambling to complete activities to help your tax situation.
- Get off autopilot: It is not uncommon to see farmers make financial decisions that they shouldn’t have made because their books are not up to date. Examples include buying the same amount of prepaids as last year or making a capital expenditure because you had to last year – only to find out that neither were necessary because you were in a loss position. The opposite may be true this year with the government aid you may have received.
- Nothing is irrelevant: Make sure you tell your tax preparer about all equipment purchases. If equipment is dealer or manufacturer-financed, it may not show up in your bank accounts if no payment was made in the tax year. That can be a sizeable capital expenditure that your tax accountant doesn’t know about unless you tell him.
- Meet with your tax accountant: Meet before the end of the year to discuss your current financial situation and what tax bracket you’re likely to be in. Allow enough time to bring in additional income if facing a net operating loss or to make additional purchases if your income is too high.
Don’t be a victim with your income tax situation. Do what you can to control your income tax situation.
FREQUENT TAX PLANNING STRATEGIES
From a tax standpoint, there is only one big change this year that will impact many farming customers. We published a blog about it earlier this year. Bonus depreciation rules changed effective January 1, 2023. Bonus depreciation is one of the most effective tax minimization planning tools farmers have available to them is the use of accelerated depreciation – in the form of section 179 deductions or the use of bonus depreciation. These strategies have been around for decades in one way, shape or form.
The 100% bonus depreciation begins to phase down effective January 1, 2023, at which point it will only be 80%. In other words, a $700,000 tractor you purchased is maxed at $560,000 of bonus depreciation in 2023, with $140,000 being depreciated over a seven-year period.
Bonus depreciation will drop after 2023 according to the following schedule:
- 60% in 2024
- 40% in 2025
- 20% in 2026
- 0% in 2027
As you can see, the impact will continue to increase in future years as the depreciation percentage you are allowed to take reduces going forward. It is important to note that if you are below the section 179 thresholds, you may not see an impact. We will likely see a greater use of section 179 going forward.
You can read the full article on the changes to bonus depreciation here.
There are a few tax planning strategies to highlight – again, each may not be applicable given your operations circumstances, but are nice to have on your radar.
Methods to decrease taxable income:
- Farm income averaging: averaging all or some of your farm income using rates from the three prior years.
- Common expenditures to reduce taxable income: prepaying inputs and other allowed items, capital expenditures, and retirement contributions. See above for new details on bonus depreciation. Depending on your entity structure, retirement plan contributions can be significant, especially for self-employed individuals via a SEP, simple or other qualified plan. This also establishes retirement assets outside of the farming operations – diversification is a good thing!
- Healthcare deductions: creating an employee benefits deduction to allow for business deduction of these expenses.
- Selling under a deferred contract: you can sell grain before the end of the year, but not be paid until after the first of the next year. You then have flexibility to decide, after the fact, if you need additional income in the year that the crop was sold. Make sure you sell in several small contracts rather than one large contract to provide more flexibility for when to show income. Also, consider the risk of collection in your decision-making process.
- Charitable contributions: farmers generally tend to donate to charity near the end of the year, and as a farmer, there is a tax advantaged way to make those donations. See below for more details!
As a farmer you can donate commodity inventory to charity; instead of selling that commodity then giving the charity cash, this approach comes with its advantages.
- Due to the increased standard deduction in the 2018 federal tax law changes, many individuals are not receiving any benefit from their charitable contributions. Donating commodities allows you to still deduct the cost of producing commodities against your farm income.
- Provides for lower sales on the farm and may save you income tax and self-employment tax.
- Provides for lower farm income and a lower AGI, which may help you when it comes to credit and deduction phase outs.
- As a simplified illustration assume that farmer David and his wife Megan generally donate 5,000 a year to a local charity and can’t itemize their deductions.
As you can see in the above chart, the tax savings is $1,306 by changing the process in which you make your donation!
Methods to increase taxable income:
- Elect to capitalize repairs rather than expensing them – it can be adjusted annually.
- Maximize depreciation methods, including direct and bonus expenses – try to never depreciate your way out of standard deductions and exemptions.
- If a farm loss is inevitable, common ways to increase income include: IRA distributions, IRA to Roth IRA conversions, sale of non-farm capital assets (i.e. stocks).
An IRA to Roth IRA conversion generates taxable income on the tax return, but the earnings are tax free. Any farm losses may be offset by the income generated from the rollover and no income taxes would be owed on the money rolled into the IRAs.
WRAP-UP
Income tax planning is where your tax accountants provide the most value to your business operation. If you come with good information to the meeting, you can make the best decisions for your operation on a short-term and long-term basis. Strategies listed within this article are commonly used; however, everyone’s situation and position is unique. Go into your tax planning sessions with the mindset that nothing is irrelevant. Remember your tax accountant can’t read your mind. Keep your records up to date so that you can make educated decisions and receive sound advice. Control what you are able to control!
