Income tax is a huge cost on any farming operation, because as farmers we can't depreciate land purchases.
Since tax season is coming up, it’s time to talk about some of the best income tax management strategies for farmers. Here are three of the best.
1. Prepaying Expenses to Manage Income
If you had an elevated income because of deferred income that you’ve realized in this year, a great way to get that income down is by prepaying your expenses. Most farmers are familiar with this strategy: you’ve probably prepaid for things like seed expenses.
A lot of times, you get the best discount when you prepay as well. So not only do you get the best prices, you also get to use the next year’s expenses to offset the previous year’s income.
Prepaying inputs like seed, fertilizer, and chemical is really a no-brainer. You could even prepay some rents in order to manage income tax.
2. Deferred Income
The awesome thing about farming is that we go on the cash accounting basis. In other words, you don’t realize income until you’ve received the cash.
For example, if we were on an accrual basis, when we harvested a field we would have to realize the income right then. But we can harvest a cornfield, sell it to a co-op, and have a fat check sitting at the co-op but defer the income.
Right now, if you commit to anything less two years, co-ops are paying less than 2% on the money. If you commit to anything over two years, they’ll pay more. But of course if the co-op goes bankrupt, you’re in a bad situation. Choose wisely.
If you have done some forward contracting on your marketing and are filling contracts at harvest but don’t want to take that income for fear of entering a high tax bracket, deferment income is a great strategy.
3. Income Averaging
As farmers, we get three years of income averaging.
Let’s say three years ago, you had a loss of $200,000, last year you had a $200,000 gain, and this year you’ve got a $400,000 income. What you can do is basically average that over the last three years (you’ll get roughly $133,000). Rather than being in a 33% tax bracket, you’ll drop down into about a 25% tax bracket.
When you prepay and defer your income, always take the last three years into consideration. The last thing you want to do is have a low income for two years straight, then have a huge tax liability that’s snowballed.
You want to pick your income tax bracket and do your best to keep yourself there. You don’t want it to snowball into a big problem.
Final piece of advice: pay taxes. You do want to pay taxes, because if you ever want to borrow money and you’ve paid no taxes because your income is always zero or negative, it’s going to make you look bad.
So pay those taxes, and don’t let them snowball into a huge, crazy year.
This post was based on an episode of the Cash Cow Farmer Podcast. To hear more content like this in audio form, subscribe to the show here.
Scott is a South Dakota farmer who formerly worked in investment banking on Wall Street. After the commodity markets crashed, Scott took his financial know-how and built a software program for farmers called Cash Cow Farmer, which empowers farmers to master the business side of farming by knowing real-time field-by-field productivity and profitability. Scott consults with farmers all over the United States on risk and financial management, farm strategy and strategic growth. Contact him at firstname.lastname@example.org
The opinions of the author are not necessarily those of Farm Futures or Penton Agriculture.