December 11, 2019
Many producers’ initial reaction to tax planning is often tax avoidance — they’ll say, “I don’t want to pay any tax at all,” or “I want to pay less than last year.”
However, tax professionals point out that the focus of tax planning shouldn’t be on solely paying the minimal tax; it should be about paying the right amount to maximize tax benefits and minimize taxes over the long term.
So, what’s the “right amount?” That depends.
Good tax planning focuses on both the current year and long-term goals.
There may be years when paying no tax is the best plan, but it’s important to be aware of the implications of simply prepaying to defer tax liability.
A reduction in available funds to prepay could dangerously deplete working capital and cause a higher-than-usual tax bill at a very inopportune time.
It’s also important to consider the consequences of taking on additional debt to finance tax deductions. Taking on more debt to finance equipment and deducting those assets could increase cash-flow requirements and result in loan payments having to be paid off with after-tax money. This could increase taxes in future years.
Adjusting for the ‘right amount’
Inevitably, businesses will need to report taxable income for personal or nondeductible withdrawals to accumulate cash savings and permanently pay off debt from acquiring nondepreciable assets such as land or personal residences.
Still, agricultural producers and small businesses have lots of flexibility to adjust their tax due from one year to the next. Some producers have flexibility when they sell their products and set payment terms. They can reduce income by investing in new equipment, building inventory or prepaying for future expenses, among other options. This flexibility gives producers a great opportunity for tax planning rather than simply waiting until the following February or March to be surprised by a tax bill.
Be proactive
I like to spend time with my clients discussing how they can build working capital, accumulate savings and pay down debt with after-tax money.
In addition to the usual conversations, I like to discuss tax planning tools such as tax deferral techniques, maximizing tax brackets, using farm income averaging, creating long-term capital gain income and minimizing self-employment income, just to name a few.
Any discussion on tax planning should focus on maximizing income and reducing the effective tax rate rather than simply reducing the total tax dollars.
As the end of 2019 nears, I challenge producers to take a multiyear approach and ask their tax advisers to help them develop a long-term tax strategy that will work for the continued success of their business.
Myers is the financial services leader in Farm Credit East’s Flemington, N.J., office.
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