November 15, 2023
by Chad Zagar
As we get close to the end of the year, many farmers start thinking about how to minimize tax liabilities. Tax planning is the steps taken to minimize liabilities to ensure all available allowances, deductions, exclusions and exemptions are working together in the most tax-efficient manner — and to reduce the total income tax paid to an amount a customer is anticipating.
Most importantly, however, effective tax planning helps customers avoid surprises at tax season. Effective tax planning helps businesses achieve their financial goals and plan for their upcoming needs. It should lower taxable income, reduce tax rates, provide for greater control of when taxes get paid, and maximize deductions and credits whenever possible.
First, what can you control? Farmers need to be transparent with their tax accountant in the process and communicate financial goals. Remember, your tax accountant is not a magician. Here’s a few accounting best practice tips to help tax planning:
Get your records in order. Having an accurate set of financial records is critical for a tax preparer to work with — this doesn’t mean a shoebox with a bunch of receipts. A computer program or a worksheet that reconciles back to your bank statements and debts should be completed, at a minimum. If you don’t have that set up and do not have the interest or ability, consider getting help with your bookkeeping. It’s part of the operation that can’t be ignored.
Don’t procrastinate. Waiting until the last minute to get records in order is a big no-no. Waiting until late in December to start your bookkeeping for the year leaves you scrambling to complete activities to help your tax situation.
Get off autopilot. It is not uncommon to see farmers make financial decisions they shouldn’t have made because books are not up to date. Examples include buying the same amount of prepaids as last year or making a capital expenditure because you had to last year — only to find out neither were necessary because you were in a loss position. The opposite may be true this year with the government aid you may have received.
Know that nothing is irrelevant. Make sure you tell your tax preparer about all equipment purchases. If equipment is dealer- or manufacturer-financed, it may not show up in your bank accounts if no payment was made in the tax year. That can be a sizable capital expenditure your tax accountant doesn’t know about unless you tell him.
Meet with your tax accountant. Meet before the end of the year to discuss your current financial situation and what tax bracket you’re likely to be in. Allow enough time to bring in additional income if facing a net operating loss or to make additional purchases if your income is too high.
Frequent tax planning strategies
From a tax standpoint, there is only one big change this year that will affect many farming customers. Bonus depreciation rules changed effective Jan. 1. One of the most effective tax minimization planning tools farmers have available to them is the use of accelerated depreciation — in the form of Section 179 deductions or the use of bonus depreciation. These strategies have been around for decades in one way, shape or form.
The 100% bonus depreciation began to phase down effective Jan. 1, at which point it was only 80%. In other words, a $700,000 tractor you purchased is maxed at $560,000 of bonus depreciation in 2023, with $140,000 being depreciated over a seven-year period.
Bonus depreciation will drop after 2023 according to the following schedule: 60% in 2024; 40% in 2025; 20% in 2026; and 0% in 2027.
As you can see, the impact will continue to increase in future years as the depreciation percentage allowed reduces going forward. If below Section 179 thresholds, you may not see an impact. We will likely see a greater use of Section 179 going forward.
Read the full article on the changes to bonus depreciation here.
Adjust taxable income
There are a few tax planning strategies to highlight. Each may not be applicable given your operations circumstances, but they are nice to have on your radar.
Here are some methods to decrease taxable income:
Farm income averaging. Average all or some of your farm income using rates from the three prior years.
Common expenditures to reduce taxable income. Prepay inputs and other allowed items, capital expenditures and retirement contributions. See above for new details on bonus depreciation. Depending on your entity structure, retirement plan contributions can be significant, especially for self-employed individuals via a SEP, simple or other qualified plan. This also establishes retirement assets outside of the farming operations.
Health care deductions. Create an employee benefits deduction to allow for business deduction of these expenses.
Selling under a deferred contract. You can sell grain before the end of the year, but not be paid until after the first of the next year. You then have flexibility to decide, after the fact, if you need additional income in the year that the crop was sold. Make sure you sell in several small contracts rather than one large contract to provide more flexibility for when to show income. Also, consider the risk of collection in your decision-making process.
Charitable contributions. Farmers generally tend to donate to charity near the end of the year, and as a farmer, there is a tax advantage to donating grain.
Here are some methods to increase taxable income:
Elect to capitalize repairs rather than expensing them — it can be adjusted annually.
Maximize depreciation methods, including direct and bonus expenses — try to never depreciate your way out of standard deductions and exemptions.
If a farm loss is inevitable, common ways to increase income include IRA distributions, IRA to Roth IRA conversions and sales of non-farm capital assets (i.e. stocks).
An IRA to Roth IRA conversion generates taxable income on the tax return, but the earnings are tax free. Any farm losses may be offset by the income generated from the rollover, and no income taxes would be owed on the money rolled into the IRAs.
Income tax planning is where your tax accountants provide the most value to your business operation. If you come with good information to the meeting, you can make the best decisions for your operation on a short-term and long-term basis.
Strategies listed within this article are commonly used. However, everyone’s situation and position are unique. Go into your tax planning sessions with the mindset that nothing is irrelevant. Remember your tax accountant can’t read your mind. Keep your records up to date to make educated decisions and receive sound advice. Control what you are able to control.
Zagar is vice president and managing director of tax and accounting for GreenStone Farm Credit Services.
Source: GreenStone Farm Credit Services
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