Farmer tax tips for 2011 focus on the “big picture”
Tax time is here and it is a good time to step back and take a look at your business. Successful tax planning requires the taxpayer to examine the “big picture” of their operation. Here are a number of items to think about.
Qualified Farmers: Special rules exist for the payment of estimated tax and filing deadlines for individuals who are “qualified farmers.” For 2011, a qualified farmer is an individual who derived at least twothirds of their gross income from farming in 2010 or 2011.
Deadlines: April 15 falls on a Sunday this year so the Federal Filing Deadline is Tuesday, April 17. Qualified farmers who paid their estimated tax timely, have until April 17 to file their 2011 federal tax return. Qualified farmers who owe income tax and did not pay estimated taxes by Jan. 17, 2012, must file no later than March 1, 2012, to avoid paying late payment penalties. Filing deadlines for New Mexico returns is April 17.
Personal Deductions: The personal deduction for 2011 is $3,700 per dependent. If someone else can claim you as a dependent, then you cannot claim your own personal exemption. Also, taxpayers cannot claim anyone who files a joint tax return with his or her spouse as a dependent. Spouses filing a joint return can claim two personal exemptions, one for each spouse, even if one spouse earns all the income. If someone else supports one spouse, then that other person can claim the dependent and the personal exemption only if the spouses file separate returns.
For example, John and Mary are married. Mary lived with her parents all year while John was serving in the military. Mary was a full-time student and did not have any income. Mary’s parents can claim her as a dependent only if John and Mary file separate tax returns. If John and Mary file a joint tax return, Mary’s parents cannot claim her as a dependent. Personal exemptions were previously subject to phase-out limits, called the personal exemption phaseout (or PEP). The phase-out limits will not apply for the year 2012. The limitations on personal exemptions will re-surface in 2013 unless further legislation is passed to address this issue.
Self-Employment: For 2011, the social security part of self-employment tax decreased from 12.4 percent to 10.4 percent. The Medicare part remained unchanged at 2.9 percent. Therefore, the total selfemployment tax was reduced from 15.3 percent to 13.3 percent.
Drought provisions: If a producer is forced to sell livestock in excess of normal levels due to shortages of water, feed or other consequences of drought, the income tax on the gain from the sale of those animals may be postponed. Producers have two distinct tax options available to them in this circumstance:
Tax Treatment #1, Code Section 451(e): The election to postpone reporting the taxable gain on the additional sales of any livestock for one year; or Tax Treatment #2, Code Section 1033(e): The election to postpone, and altogether avoid, paying taxes on the gain from the sale of breeding, draft or dairy animals if they are replaced within a specified time frame.
Both Tax Treatments require that drought sales exceed the normal level of sales. Eligibility for the two different treatments depends on the class of livestock sold and whether the federal government has designated your area as eligible for assistance. In the case of the latter, all 33 New Mexico counties received federal designation.
Farm employee: Form W-2 must have been furnished to an employee by Jan. 31 and Form W-3 along with Form W-2 Copy A must have been filed no later than Feb. 29, 2012. All cash wages you pay an employee during the year for farm work are subject to social security and Medicare taxes and federal income tax withholding if either of the two tests below is met.
You pay cash wages to an employee of $150 or more in a year for farm/ranch work (count all cash wages paid on a time, piecework or other basis). The $150 test applies separately to each farmworker whom you employ. If you employ a family of workers, each member is treated separately. Do not count wages paid by other employers.
The total you pay for farm/ranch work (cash and noncash) to all your employees is $2,500 or more during the year.
Generally, a worker who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is you have the right to control the details of how the services are performed.
You are responsible for withholding and paying employment taxes for your employees. You are also required to file employment tax returns. These requirements do not apply to amounts you pay to independent contractors, and it is imperative you do not treat farm/ranch employees as contract labor, as penalties can be significant.
In general, you are an employer of farm/ranch workers if your employees:
• Raise or harvest agricultural or horticultural products on your farm, including the raising and feeding of livestock;
• Work in connection with the operation, management, conservation, improvement or maintenance of your farm/ranch and its tools and equipment;
• Handle, process, or package any agricultural or horticultural commodity if you produced over half of the commodity (for a group of up to 20 unincorporated operators, all of the commodity); or
Do work for you related to cotton ginning, turpentine, gum resin products or the operation and maintenance of irrigation facilities, and/or livestock facilities.
Generally, the wages you pay to family members who are your employees are subject to social security and Medicare taxes, federal income tax withholding and FUTA tax. However, certain exemptions may apply for your child, spouse or parent.
Employee Exceptions: The $150 and $2,500 tests do not apply to wages you pay to a farmworker who receives less than $150 in annual cash wages and the wages are not subject to social security and Medicare taxes, or federal income tax withholding, even if you pay $2,500 or more in that year to all of your farmworkers if the farmworker is seasonal labor:
• Is employed in agriculture as a hand-harvest laborer,
• Is paid piece rates in an operation that is usually paid on a piece-rate basis in the region of employment,
• daily from his or her permanent home to the farm, and
• Had been employed in agriculture less than 13 weeks in the preceding calendar year.
Amounts you pay to these seasonal farmworkers, however, count toward the $2,500-or-more test to determine whether wages you pay to other farmworkers are subject to social security and Medicare taxes.
Employers must provide Form 1099 by Jan. 31, 2012, to contractors paid more than $600.
Small business: You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
• Business start-up cost
• Business assets
2011 was a banner year for Section 179. That’s because legislation passed during the latter half of 2010 expanded and enhanced Section 179 and Bonus Depreciation to new, unseen limits. The total deduction was doubled, to $500,000, and the total limit of equipment purchased was raised to $2,000,000. This deduction means taxpayers can choose an immediate writeoff for assets instead of recovering this amount over the depreciation period of the asset purchased. Eligible assets include equipment and breeding assets.
Depreciation: Depreciation is also allowed on purchased livestock acquired for breeding, draft, and sporting purposes, unless the rancher uses the accrual method of accounting and the livestock is included in inventory. A significant expense on a ranch return is depreciation.
The same depreciation rules apply to farming and ranching as to any other business. In addition to MACRS, farmers and other taxpayers have three options for depreciating property acquired after 1986 (IRC § 168).
• Use straight-line method over the regular MACRS recovery period.
• Use straight-line method over the regular Asset Depreciation System (ADS) midpoint (also know as class life or ADS class life). This method is usually referred to as alternative MACRS.
• Use 150 percent declining balance method over the longer ADR midpoint life. This method is available for property other than real property, and is usually referred to as 150 percent MACRS.
Farm or ranch property placed in service after 1988 is limited to the 150 percent declining balance on property used in a farming business with less than a MACRS recovery period of 15 years, rather than the 200 percent available for non-farm property. This change was enacted with TAMRA 88.
Family members as employees: Payments must be reasonable, reflect the going rate and be paid periodically. Wages are deductible as an ordinary farm/ranch expense.
Health insurance: If you have self-employment income, then you can take a deduction for health insurance expenses incurred for yourself, your spouse and your dependents. Who can claim the self-employed health insurance deduction?
Self-employed people reporting income on Schedule F (for farmers) or Schedule C (other self-employed persons).
General partners in a partnership and actively participating members in an LLC treated as a partnership who have self-employed income.
Employees of an S-corporation who own 2 percent or more of the s-corporation’s stock.
You can deduct the full cost of health insurance you purchase for yourself, your spouse and/or your dependents from adjusted gross income. However, this cost cannot be deducted from self-employment earnings.
Before claiming this tax deduction, you must calculate your allowable health insurance deduction. Take your self-employment income, and subtract the 50 percent deduction for selfemployment taxes, and subtract any retirement contributions you make to SEP-IRA, SIMPLE-IRA, or Keogh plan. The remainder is your allowable deduction for health insurance expenses.
Health Insurance Deduction in a Loss Year: If you are reporting a loss from your self-employed activity, then you are not eligible to deduct your health insurance costs since this particular deduction is limited by your selfemployment income. You can however still claim the health insurance expenses as an itemized medical deduction on your Schedule A. You claim the health insurance deduction as an “above the line” tax deduction on Form 1040. Any health insurance premiums that you cannot deduct directly on Form 1040, you may be able to deduct as a medical expense on Schedule A.
Prepayment of expenses: You can deduct an expense for prepaid farm/ ranch supplies that does not exceed 50 percent of your other deductible farm/ ranch expenses—non-prepaid expenses in the year of payment. You can deduct an expense for any excess prepaid farm/ranch supplies only for the tax year you use or consume the supplies. Prepaid expenses must be for supplies that are essential to the farm/ ranch operation and can include fuel, feed, fertilizer, or seed prices. Pre-paid expenses beyond tax year supplies must be for sound business reason—i.e., anticipated price increase for fuel, feed, fertilizer, or seed. This useful planning tool is a good method to juggle fluctuating income and expense.
Conservation Expenses: Improvements made to soil and water conservation provide deductible expenses, not in excess of 25 percent of gross income, provided they are consistent with an approved conservation plan.
Professional fees: Payments to accountants, attorneys and other professionals are deductible as legitimate business expenses if associated with the business. Keeping in mind any legal fees paid to an attorney for business reasons will always trigger a 1099 Misc. Fees for preparation of schedule F and related forms are deductible, but fees for personnel tax form preparation of a return go on schedule A. Examples of exceptions are fees for will preparation, title work and most divorce costs.
Tax season is upon us. It is difficult to do any tax planning for 2011, but the whole process should alert you to the gaps in your current yearlong business planning. Tax season is a good time to do some cash flow planning for the coming year. As you are summarizing revenue and expense records from 2011, use a cash flow projection to estimate revenue and expenses for 2012; this will help make tax-planning part of the “big picture.” — Paul Gutierrez and Patrick Sullivan, Extension Economists, New Mexico State University