2019 has provided many challenges. Conversations started out discussing rainfall, planting dates and loss of nitrogen, but cash flow has been the underlying concern for most producers. As Dec. 31 approaches, producers need to carefully consider cash flow needs to pay the upcoming income tax bill.
Getting a tax estimate before the end of the year is critical regardless of your income. For high-income individuals, the reasons are obvious. However, because of the numerous tax credits and deductions, it is equally important for lower-income producers to get a tax estimate made.
It’s important to remember the goal of a good tax plan is to minimize the total tax liability incurred over time. Let’s look at some common examples that can be used by cash basis farmers if they need to adjust their farm income:
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 some farmers overlook.
Consider income averaging. Depending on the prior year’s taxable income, income averaging may decrease your tax liability.
Review Commodity Credit Corporation 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.
Review deferred payment contracts. For maximum flexibility, consider multiple smaller contracts, because the installment sale election is on a contract-by-contract basis.
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 will couple or decouple from these. Check on the depreciation rules for your state.
Also, for 2019, the federal bonus depreciation is 100% on qualified assets. And the Section 179 deduction is $1.02 million. Section 179 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 $2.55 million. Thus, if qualified purchases exceed $3.57 million on qualified assets, the quick write off election is reduced to zero.
Consider how your decisions will impact your profitability and cash flow. Just because a capital purchase will decrease your tax liability doesn’t make it a good management decision. For example, if you purchase farm equipment (five-year depreciable property) and it’s financed over five years, the principal payments needed are close to the depreciation expense.
However, if you elect to expense out the entire cost this year, you will have no depreciation left to use as an expense. Many times, this can have a snowball effect because the increased cash flow needed for payments creates a tax liability problem when paying principal payments with after-tax dollars.
And remember to consider last year’s tax laws changed regarding “traded assets.” To clarify, in 2019 a tax-free exchange is only available for real property. This change means any equipment trades (personal property) must be treated as a sale and a purchase.
For example, if you trade in a tractor with a fair market value of $75,000 on a new tractor and paid $100,000 difference (boot), you will need to report the old tractor as a sale of $75,000 and recognize any taxable gain (sale price minus tax basis). Then you will report the purchase of the new tractor valued at $175,000 ($75,000 trade value plus the boot). It’s important to be aware of this change for record keeping and tax planning. Especially because offsetting gain on traded equipment with bonus depreciation, or the Section/179 deduction, could easily create a negative Schedule F, thus reducing Social Security tax.
Fund your retirement account, such as IRA, SEP, Keogh. Because some plans need to be set up by Dec. 31, be sure to check into this now. The limits for 2019 for the traditional deductible retirement accounts are for IRAs. or SEP and Keogh.
Traditional IRAs are available to any individual under the age of 70.5 with earned income. For 2019, the maximum contribution is $6,000 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 $7,000.
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 $103,000.
The SEP and Keogh 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 $56,000. However, certain already-established plans may have different contribution percentages and limits. See IRS Publication 560 for complete details.
These are some of the most common strategies and considerations. However, because of tax law changes, be sure to review your tax estimate with your tax consultant. An hour with a tax consultant in early December can save you thousands of dollars.
Vickre is coordinator of the Iowa Farm Business Association. Email firstname.lastname@example.org or call 515-233-5802.