NOTE: Kent Vickre is state coordinator of the Iowa Farm Business Association.
As the year end quickly approaches, most producers are busy crunching their numbers and working on their "tax plan." As a reminder, a key consideration should be tax management and not simply tax avoidance. A good plan should consider tax brackets, income averaging and both tax deductions and phase-out of credits and limits.
To help decide on your level, it's important to review your current profit. You should consider both taxable income and accrued income when making financial management decisions. Taxable income is your income reported on the tax return. Accrued income is calculated using inventory change and economic asset depreciation. This method best reflects your "earned income."
Decide on an "optimum income level" for tax planning
By comparing both of these incomes, you can gauge how much tax liability you are shifting into the following years. This should help you decide on an "optimum income level" to use for your tax planning.
Below are some common examples that can be used by cash basis farmers to adjust your farm income. Also, as of writing this article, the depreciation options are much less favorable this year. The Bonus Depreciation is no longer available for 2015 and the quick write-off has been reduced from $500,000 in 2014 to $25,000 in 2015. However, if past years have been any indication, an increases quick write-off limit and the bonus deprecation could be restored by Congress. Keep a "watch" on these deprecation items as the year end approaches.
Farm income adjustments you may want to consider
* Prepay operating inputs. Be sure to specify a quantity and price. Remember, prepaid expenses are limited to 50% of deductible expenses.
* Defer crop insurance proceeds. You may elect to defer income to the following year if you meet specific conditions, such as: You use the cash method of accounting; you receive the crop insurance proceeds in the same year that the crops were damaged; you can show that, under normal business practice, you would have included income from the damaged crops in any tax year following the year the damage occurred.
Also, only crop insurance proceeds paid because of crop damage or the inability to plant crops are eligible for the deferral under Internal Revenue Code 451(d). To clarify, insurance policies that have both a yield and price component such as Revenue Protection (RP) will require a separate calculation. To calculate the deferral amount, you must calculate a percent of physical loss compared to the total loss.
* Pay your children a reasonable wage for farm work. You don't have to pay Social Security tax on your children under age 18. You must file the appropriate payroll tax forms.
* Pay any accrued interest. It's a potential tax saver that some farmers overlook.
* Consider income averaging. Depending on the prior year's taxable income, income averaging may decrease your tax liability.
* Double up on church or charity contributions. If you itemize, consider donating more or paying state income tax in December instead of waiting until the following year.
* Review CCC loan tax treatment. If you have "sealed grain" carrying over at year-end, simply electing to change the tax treatment may increase or decrease your taxable income. You may need to file additional forms with your return.
* Consider and review deferred payment contracts. For maximum flexibility, consider multiple smaller contracts. Since the installment sale election is on a contract-by-contract basis.
* Buying capital assets. Consider purchasing needed capital assets such as equipment, buildings or breeding livestock. The federal depreciation rules are described below; however, each state decides if they'll couple or decouple from these. Check on the depreciation rules for your state.
What about the bonus depreciation for purchased capital assets? Currently, this is not available for the 2015 tax year. However, you can use the "quick write off" depreciation for purchased capital assets. For 2015, the Section 179 deduction is $25,000. The 179 election is limited to qualified capital purchases for items such as equipment, grain bins or breeding livestock with a dollar-for-dollar phase out starting at $200,000. Thus, if qualified purchases exceed $225,000; the entire $25,000 quick write off election is reduced to zero.
* Fund your retirement account—IRA, SEP, Keogh. Because some plans need to be setup by Dec. 31, be sure to check into this now. The limits for 2015 for the traditional deductible retirement accounts are:
* Traditional IRA. These are available to any individual under the age of 70½ with earned income. For 2015, the maximum contribution is $5,500 or your earned income (whichever is less). Individuals age 50 or older also can make an additional $1,000 "catch up" contribution; this increases the limit to $6,500. However, be aware of income phase-out limits. These phase-out limits differ depending on filing status (married filing joint, head of household, single, etc.) and the type of IRA (traditional or spousal). For example, if you are married, filing a joint return and were eligible to participate in an employer-sponsored plan such as a 401, the IRA contribution drops when your income exceeds $98,000.
* SEP/Keogh. These retirement plans may permit greater contributions and deductions. However, you generally will run into provisions requiring contributions for other employees who meet certain minimum qualifications. The deduction is limited to a percent of net self-employed income minus the self-employment tax deduction for the self-employed individual or a percent of wages for an employee. The maximum level is 20% for a self-employed individual and 25% of wages for an eligible employee with a maximum limit of $53,000. However, certain already-established plans may have different contribution percentages and limits. See the IRS publication 560 for complete details.
Prepare an estimate now of your 2015 income tax
These are several of the most common strategies. A good plan should consider all of the variables, such as tax brackets, tax deductions and phase-out of credits and limits. However, it can't be emphasized enough that because of tax law changes that preparing a tax estimate with your tax consultant before December 31 is essential.
Vickre is state coordinator of the Iowa Farm Business Association. Contact him at [email protected] or 515-233-5802.