Avoid farming's tax time bomb

Dec 13, 2013
by DTN

Traditional year-end tax planning is all about deferrals—commodity revenue pushed to the next year and expenses accelerated into the current year. And the tendency is to set reportable taxable income below actual earnings. The result is a continuously increasing income deferral that becomes a tax disaster at retirement when it’s recognized.

How about creating a major deduction today that pushes the income down the road 30 to 50 years, while compounding tax-free? A qualified retirement plan can do this. But what is often overlooked is the duration of the deferral and also the magnitude of dollars that can be sheltered.

The deferral aspect

Qualified retirement plans do more than simply push income out to retirement years. A participant must begin withdrawals at age 70 1/2. But early year withdrawals are less than 4 percent of the plan value. If the plan owner sticks to the legal minimums, it isn’t until the mid-80 age range that the required distributions rise to around 6 percent and perhaps outstrip plan growth.

When we pass these ac counts after death to the next generation, another deferral period applies. Each beneficiary, normally a child, can set up an extended lifetime payout that may add another 30 years before the last dollars are distributed.

Retirement Plan Alternatives

The tax law is a mess these days in terms of plan alternatives: SIMPLEs, SEPs, 401(k) plans, etc. The amount of funding desired, as well as whether there are employees to be covered, will often drive the choice. If the goal is about $50,000 per year of funding or less, it is relatively easy to get there without much complexity.

But if you are that 60-yearold with deferred grain sales of $1 million and retirement on the near horizon, you will want to consider a cash balance defined benefit plan.

You will need to have sufficient earned income from your farming business to support the retirement plan funding. If you are reporting at the $250,000 income level, an age-based plan could produce a deduction in the $220,000 vicinity for a 60-year-old. Do that five years in a row, and you have created a long-term deferral on some real money! Even a 50-year-old can shelter some hefty dollars, roughly about $140,000 per year.

These plans do require a five-year minimum of funding, so they are ideal for the older proprietor who has significant grain deferrals and is a cinch to have strong income in the remaining years of farming. An issue may be the funding for employees, although only those working at least 1,000 hours per year are counted. A typical result for employees is about 8-12 percent of compensation as the annual retirement plan contribution from the business.

Because of the sophistication of these plans and the design work, there will be fees. Normally, there is a setup and design charge, and then the annual plan administration. But if the result is taking about $1 million of looming income and parking it in a long-term tax-deferred plan that is exempt from creditors, the costs are very reasonable. — Andy Biebl, DTN Tax Columnist [Andy Biebl is a CPA and tax partner with CliftonLarsonAllen LLP in Minneapolis and a national authority on ag taxation. To pose questions for upcoming columns, email AskAndy@dtn.com]