By Troy Schneider
Benjamin Franklin once wrote in letter to a friend: "In this world nothing can be said to be certain, except death and taxes." Old Ben was right that all farmers will die; however, farm income tax planning is a lot less certain.
If it seems as though farm incomes have become more volatile over the last several years, they have. According to USDA statistics, the standard deviation of net farm income from 2000 to 2006 was $15.8 billion compared $20.3 billion for 2007 to 2013. According to farm experts, this volatility is due to extremely unpredictable commodity prices and production expenses that have increased every year since 2006.
When there is so much variation annually as to farm incomes, it can make tax and business planning extremely difficult for farmers. The following are several tax tools farmers use to lower and/or defer income in a high income year and utilize from a low income year.
Deferral of income
In general, any proceeds are taxable in the year you had the right to receive them. The key definition is "right to receive". Income is generally received when it is subject to the person's control. Specifically, Treasury Regulation Section 1.451-2 provides that "income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given."
For example, a farmer cannot instruct the milk plant to "hold the milk check" until after Jan. 1and then report the income in 2015. However, income is not constructively received if the farmer's receipt of the milk check is subject to substantial limitations or restrictions. In other words, to have milk income deemed received in 2015, the farmer and his milk plant could have a signed agreement stating that milk produced during a certain period in 2014 will be paid in 2015.
Internal Revenue Code Section 1301 allows farmers to use lower unutilized tax brackets of the previous three years in calculating the current year's income tax liability. For example, if a farm were in the 33% tax bracket this year and the farmer did not fully utilize all of the 25% and/or 28% tax brackets during the previous three years, the unutilized amounts can be used in the calculation of the current year's tax liability. Farmers can also make or change an election for farm income averaging on an amended tax return.
Net operating losses
As you know, a period can occur where a farm incurs more expenses than revenues, resulting in a loss. This net operating loss for the farm can generally be used to recover past tax payments or reduce future tax payments.
A farm can use the loss to earn a refund from the IRS for taxes paid in previous years. This carryback period is usually up to three years, depending upon the type of loss. A farm also has the option of waiving its carryback period and using all its losses going forward for up to 20 years. The deductions used in calculating an NOL vary, therefore, calculating the net operating loss can be complicated.
Section 179 expensing
For qualifying property purchased and placed in service during the year, the Section 179 deduction allows a farm to deduct up to $25,000 of the property's cost in the first year, rather than to gradually depreciate that cost over the property's useful life. In the recent past, the annual limit was $250,000 for a farm's 2008-2009 tax years and $500,000 for its 2010-2013 tax years.
The $25,000 deduction limit is reduced dollar-for-dollar to the extent that the cost of the qualifying property exceeds $200,000. As a result, if a farm were to buy and place $225,000 in qualifying property in service during 2014, then the expense deduction would be completely disallowed. The taxpayer would then need to depreciate the property over its cost recovery period, according to the usual depreciation rules. Again, in the recent past, the investment limit was increased to $800,000 for a farm's 2008-2009 tax years and $2,000,000 for its 2010-2013 tax years.
It is still possible that Congress will increase the Section 179 limits for 2014. On Dec. 3, the House of Representatives approved a bill which extends the Section 179 expensing limitation and phase out amounts in effect from 2010 to 2013 to property placed in service during 2014. In addition, this same bill also extends fifty percent bonus depreciation to property acquired and placed in service during 2014. However, in order for this bill to become law, it still must be approved by the Senate and signed by the President.
A major challenge for farms is managing income taxes. Tax management has especially become difficult given how unpredictable the farm economy has become. A farmer should never let the tax tail wag the dog when it comes to tax planning and should always favor making good business decisions over simply just trying to avoid taxes. However, with knowledge of the tax rules and careful planning, you can intelligently mitigate the effect of your farm's tax liabilities.
Schneider is a partner in Twohig, Rietbrock, Schneider and Halbach, S.C., a Chilton law firm that specializes in ag law. Call Schneider at 920-849-4999.