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How to do a better job estimating tax payments

Advice for those times when you don’t get to pay your taxes all at once.

With the 2019 tax season (finally) ending, we get to start looking ahead to next year.

For some of you, this means you get to start making your estimated tax payments for 2020.

Part of the COVID adjustments for taxes in 2020 were delaying the first and second quarter estimated payment until July 15. While it sounded good on paper, the dilemma it created was some of you needed to make, in effect, three tax payments at the same time; paying your 2019 taxes and then two estimate payments for 2020.

The farming industry is somewhat sheltered from the estimated tax dilemma but it will affect some of you. Since most farmers do not make estimated payments during the year, they can sneak up and cause unwanted surprises.

Today, we will look at when farming is affected by estimated tax payments and a little information on how they work.

IRS requirements

The IRS requires that taxes be paid on income as it is earned. For W-2 workers, companies are required to pull withholding out and send to the IRS on a regular basis. Individuals that are self-employed or operate under a partnership or LLC generally need to make estimated tax payments. I say generally – most of you reading this are probably well aware – because individuals that predominately have farming income (66.7% of gross income) are not required to make estimated payments. For the IRS definition, you more-or-less need to grow and sell the commodities yourself for it to be farming income.

The definition of farming income is important because not all agribusiness is farming in the eyes of the IRS. For you guys that do a little custom work and sell a few bags of seed every now-and-then, it’s not really a big deal because your farming income keeps you above that 66.7% threshold.

However, you need to be aware of your income sources because – if you’re not at that 66.7% - you should be making estimated tax payments through the year.

The two groups that I see being affected the most are 1) people just getting into farming and have an agribusiness operation (seed sales, custom hire, trucking) to cash flow their equipment purchases and 2) people retiring from farming and selling large portions of their equipment.

I generally recommend making estimated payments when they are required. Not paying the estimates on the due dates essentially just increases your tax rate by penalty rates; its money out the door that you can’t get back. The federal penalty/interest rates are 3.398% APR. The penalty is assessed daily on the underpayment of taxes.

The good thing is underpayment penalty is generally assessed based on the lesser of 1) 90% of your current year tax liability or 2) 100% of your previous year’s tax liability. In practice, this means you’re going to make your current year estimate payments based on your last year’s tax return to prevent getting underpayment penalties.

Let your CPA or tax preparer know when you may be coming up on years where you know there are going to be major changes in your operation. It should help prevent any additional surprises come tax time.

Bob Krogmeier is a CPA at LattaHarris, LLP in Eastern Iowa. He can be reached at BKrogmeier@lattaharris.com. By the Books is dedicated to the how and why of farm accounting transactions. 
The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 
TAGS: Management
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