It’s that time of year again! Time of start thinking about finishing the year off right and making smart tax decisions–not only for this year, but decisions that will benefit you in the future as well. The years come and go, but for farmers, change is always certain. Michigan and Wisconsin’s agricultural industries are extremely diverse. Depending on your industry, you may be experiencing an excellent year or a difficult one. While this advice may seem repetitive, it’s always wise to evaluate your tax opportunities before the end of the year to maximize the benefits.
Tax planning allows you to take steps to minimize your tax liabilities, ensuring all available allowances, deductions, exclusions, and exemptions are working together in the most tax-efficient manner to reduce the total income tax paid to an amount you are anticipating. Most importantly though – effective tax planning helps you avoid surprises come tax season. Effective tax planning helps businesses achieve their financial goals and plan for their upcoming needs. It helps to lower taxable income, reduce tax rates, provide for greater control of when taxes get paid, and maximize deductions and credits whenever possible. It can also help you manage your taxable income at a consistent level each year.
Preparing for yearend tax planning
So, first – what can you control? You need to be transparent with your tax accountant throughout the process and communicate your financial goals. Remember your tax accountant is not a magician. Here are a few best practices 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. Do not wait until the last minute to get your records in order. Waiting until late in December to start your bookkeeping leaves you scrambling at the end of the year to try to help your tax situation. Consider getting help with your bookkeeping if you do not have the capability and time to do so. It is a vital part of your operation that cannot be ignored!
- Don’t run on autopilot: Don’t make financial decisions when your 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 made because this year you were already in a loss position.
- Nothing is irrelevant: Make sure you tell your tax preparer about all equipment purchases. If the 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 does not know about unless you tell them.
- Meet with your tax accountant early: Meet before the end of the year to discuss your current financial situation and what tax bracket you are likely to be in. Allow enough time to bring in additional income when facing a net operating loss or to make additional purchases if your income is higher than you would like it to be.
Upcoming tax law changes
From a tax standpoint, there are a few looming matters you should be aware of. The Tax Cuts and Jobs Act (TCJA) of 2018 is set to expire beginning January 1, 2026. How will that potentially impact you?
- Estate and Gift Tax: The TCJA doubled the estate tax exclusion to $11.2 million per person in 2018. This exemption amount has been adjusted annually for inflation and currently sits at $13.61 million for 2024 and will be adjusted again for inflation for 2025. This exclusion will revert to the per person limit used before 2018, adjusted for inflation, which is projected to approximate $7.0 million in 2026.
- Qualified Business Income Deduction (QBID): Section 199A (QBID) is a 20% deduction for income that individuals receive from a “pass-through” business. It was intended to lower individuals’ “pass-through” business income tax rates to be in line with the corporation tax rate changes. Unless later extended or made permanent, this 20% deduction will no longer be available.
- Individual Tax Brackets: The individual income tax rate schedule is set to revert to the pre-TCJA brackets and rates, adjusted for inflation. This will result in increased tax rates other than the lowest bracket.
- Standard Deductions: The increased standard deductions for individuals will revert to lower levels in 2026 (roughly half of the current amounts) – many of you have not itemized since the TCJA changes went into effect. You may want to plan charitable contributions for this change and start tracking all personal expenses again that you would report on Schedule A of your 1040 in 2026.
Take advantage of these items while you can. Plan from an estate and gift tax perspective if your estate exceeds where the exclusions will revert to beginning in 2026. Make sure you understand how the sunset of QBID and the upcoming increase of tax rates will impact you. Should you manage taxable income increases over the next few years to pay at lower rates and save deductions for future years? Now is the time to plan ahead!
Additionally, bonus depreciation rules have changed as of January 1, 2023. Accelerated depreciation – in the form of section 179 deductions or the use of bonus depreciation - is one of the most effective tax minimization tools available to farmers.
The 100% bonus depreciation began to phase out as of January 1, 2023. In 2024, the bonus depreciation maximizes at 60%. In other words, a $300,000 tractor would be maxed at $180,000 of bonus depreciation in 2024, with $120,000 being depreciated over a seven-year period.
Bonus depreciation will drop after 2024 according to the following schedule:
- 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 an increased use of section 179 going forward.
Frequent tax planning strategies
Take a look at the tax planning strategies below, and work with your tax and accounting specialist to see if they could benefit you:
Methods to decrease your taxable income:
- Farm income averaging: Averaging all or some of your farm income using rates from the 3 prior years.
- Common expenditures to reduce taxable income: Prepaying inputs and other allowed items, capital expenditures – utilization of aggressive bonus or section 179 depreciation methodologies, and retirement contributions. Depending on your entity structure, retirement plan contributions can be significant, especially for self-employed individuals via a simple or other qualified plan (SEP). 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 receive payment until after the first of 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: As a farmer, there is a tax-advantaged way to make charitable donations via the use of commodity inventory.
Methods to increase your taxable income:
- An election to capitalize repairs rather than expensing them can be adjusted annually. In a year of losses, this can be extremely effective to capitalize these amounts and save the deductions for future years.
- Maximize depreciation methods, including direct and bonus expenses. However, you should 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 future 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.
Income tax planning provides great value to your business operations. The more useful information you can provide your tax specialists with, the better decisions you can make for your operation. The strategies listed within this article are commonly used; however, everyone’s financial situation and operation are unique. Go into your tax planning sessions with the understanding that every detail is important. Ensure your records are current to make the best decisions, receive the most accurate advice, and maximize your tax opportunities!
