It’s tax primer time - “average” farm income

Nov 18, 2011
by DTN

In times of high commodity prices, you’ll need to study up on year-end taxplanning strategies. Keep in mind that these only make sense if they fit within your business plan.

For 2011, tax math doesn’t get any better for depreciable assets: you can write off 100 percent of new assets and up to $500,000 of used assets under Sec. 179. Both are scheduled to scale back in 2012.

The key is to have documentation that is defensible if the IRS examines your return. Is that year-end check supported by an invoice that shows the purchase of a specified quantity of a specific good at a specific price? Or is it simply a receipt marked “fertilizer” or “chemicals” that the IRS will call a nondeductible deposit? Also, there should be a business reason for the prepayment (e.g. discounts, locking in a price). And finally, the quantity should not exceed the amount normally used within a 12-month period.

A cash-method farmer selling inventory on a contract has special installment sale protection in the tax law. Be sure to use a written contract, and avoid any language that allows you to elect to take the money earlier than the deferred payment date. There is nothing in the tax law that limits the duration of these contracts, but before you push that income out too far, be sure to consider the credit worthiness of the purchaser.

Farm income that is taxable in a 1040 can electively be “averaged” by applying some portion equally to the prior three years. You will need to work with your tax adviser to make the optimum election. For those who are self-employed, it can make sense to push income up when it is only at the 2.9 percent Medicare SE tax rate, using income aver aging to hold down the income tax rate.

Most farmers don’t maximize retirement plan funding. There’s a variety of retirement plans that can be selected, each with their own contribution limits and employee coverage rules. Your tax adviser can look at your income and employee mix to determine whether a SIMPLE, SEP, 401(k), defined contribution plan, or even a defined benefit plan is the best fit.

Through Dec. 31, 2011, we still have 100 percent bonus on new assets and a $500,000 Section 179 limit that can be applied to used assets. The 100 percent bonus is scheduled to drop to 50 percent in 2012, and the Sec. 179 deduction drops to $125,000 (plus some inflation indexing). So if there are any remaining equipment needs, 2011 is the year.

Finally, don’t focus on the total tax outlay, but rather on the marginal rate. The key is taking full advantage of the brackets, even if the actual tax outlay is greater than normal.

If taxable income is still high after considering these points, remember that being successful is the objective! — DTN