Three of the Best Tax Planning Strategies Explained

Susan Voss, CPA, one of the heads of the TD&T Ag team, provides the next installment in her series on helping farm families understand and respond to changes in agribusiness.
During tax planning season at most CPA firms, three basic strategies allow a tremendous amount of flexibility to the agricultural clients we serve: defer, prepay, and depreciate.  It doesn’t matter how articles, explanations, and discussions cover these three topics. It can be very confusing to determine what they mean and what situations result from various choices.  Here’s one over the plate to help you hit a home run when it comes to these three strategies.

Defer or Not to Defer – Is that a Question? 

The majority of farmers are cash basis taxpayers.  We all know we can wait to sell our products after the first of the year and report it then.  Did you know we can create a situation in which we decide whether to recognize or defer the sale of our commodity when completing our tax returns and know exactly where we are?  A deferred payment contract entered into during the current year sells the commodity this year at a given price, for delivery and payment next year.  The golden nugget is…you can count it this year, before you receive the payment OR wait until next year.  This works dandy when there are several smaller contracts out there.  You and your tax preparer can decide which ones to pull into this year and which ones to let go until next.  There can be a lot of flexibility with a lot of dollars with this scenario.  You’ll also hear the word “deferrable” when there is a natural disaster in your area.  If you receive crop insurance in the same year the crop was grown, you can elect to defer it to the following year or report it in the current year.

Prepay, but Follow the Rules

Prepaying expenses can also benefit farmers.  Prepaying can help average out a high year.  Prepays are down right now while we navigate through the current downturn, but they are far from gone.  Right now might be an opportunity to reduce your annual scramble to prepay inputs while getting into compliance with the 50% rule that frequently gets ignored.  Unknown to many farmers, there are limitations to prepaying.  Keep this in mind:  prepaid farm expenses may not exceed 50% of other deductible farm expenses.  To qualify, a prepayment must be an actual purchase rather than just a deposit, it must be consumed in the following 12 months, must have a business purpose like fixing a price or ensuring supply, and it must not materially distort taxable income.  …Distort income?  Never!

I De-preciate You?

You may recall last filing season being a little unusual.  I think we got accustomed to the big $500,000 Section 179 depreciation being determined at the last minute, but last year Iowa waited until the third week in March to decide if they were coupling with the Federal Government, allowing the big write-offs.  They extended farm returns past March 1, gave two days notice and just plain made things difficult for folks like you and me.  As of now, the $500,000 deduction rate isIN for the federal returns and OUT for the Iowa returns this filing season.  Iowa has not made the final call, but it is expected that the amount will be a meager $25,000 on the Iowa return for 2016.  Last year was our warning.

So, here are some guidelines around the $500,000 federal 179 election:  This is permanent now.  No more holding sales at farm shows while waiting for the news whether it’s in or out, like we heard about last year.  There is, however, a proposed House Bill that would allow all farm equipment, livestock, improvements and buildings to be written off as purchased in the future.  Section 179 may become a moot point under the new administration.  If it survives, the $500,000 will start to increase for inflation in 2017.
 
For now, Section 179 applies to both new and used purchases of assets with a 15-year or shorter life.  This throws tile into the mix for operating farmers…but not landlords who are not operating farmers.  Farm buildings are considered to have a 20-year life so they do not qualify.  Passenger vehicles, including SUVS, have special rules, however, there are no worries if a truck’s gross vehicle weight exceeds 6,000 pounds.  There is a point of diminishing benefit if you purchase more than $2,010,000 of assets in one year.  You can take as much or as little as you choose as long as your earned income is at least $0.  You cannot use 179 expense to take your earned income into the red.  You need to decide whether to use 179 or any other method in the year of purchase.  Once you’ve determined a depreciation method, you have to stay with that method.
 
Bonus depreciation provides another federal benefit.  Bonus is a 50% depreciation deduction of a NEW purchase, not used.  This strategy has two main benefits:  you can use it on a 20-year farm building where 179 is not allowed and you can use it to take your earned income into the red on your return.  There is a place for planning with bonus depreciation but it is used less than the 179 election.
 
If you hear your tax preparer talk about depreciation schedules and federal versus Iowa differences, these two federal benefits, 179 and bonus, are creating two separate schedules to keep track of with potentially very different results between the two.  I’m up for the new administration’s idea to just write off farm purchases as they’re purchased….but then again, there are disadvantages to that too.  What do you suppose Iowa will do if that happens?  Wait and see.
 
Standard depreciation currently spreads depreciation over the useful life of the asset.  Farm buildings are 20 years, single-purpose agricultural structures (such as hog, cattle, or poultry specific structures) are 10 years, tile is 15, vehicles are 5, semis are 3, and most equipment is 7.  You can choose to use an accelerated method or slow it down to straight line in the year it’s put into service.  There are also AMT depreciation, ACE depreciation, and Book basis depreciation.  We’ll pass on those for now.
 
I hope these three tax planning strategies give you something to think about and/or something to discuss with your tax preparer.  With these tools in your toolbox, you have a lot of flexibility.  I smile occasionally when I hear coffee shop talk that farmers get tax breaks.  They’re probably right, but don’t ever confirm silly talk like that!
 
Have a Very Merry Christmas Season,
Susan K. Voss, CPA
By | 2017-04-24T09:24:54+00:00 December 12th, 2016|Agriculture, TAX, Tax Services|

About the Author: