While it may be true that taxes are unavoidable, there are ways to make the tax process, and specifically tax season, less painful. A smooth tax season begins long before the accountant prepares the final documents for submission. With careful planning, an agricultural enterprise can take advantage of strategies that can benefit the business.
“Keep accurate and complete records,” Jerry Pierce, Jr., program coordinator of Kentucky Farm Business Management, said. “Properly identify income, expense, and capital purchases. That includes income that does not go through the bank account, like sales paid directly to a creditor,” he added.
Plan to meet with your tax professional in the last two to three months of the year to estimate the tax liability your business may have while there is still time to make adjustments. Determine which, if any, purchases are necessary as they relate to buildings, tractors and equipment. Before rushing in to make a purchase, be certain it is good for the business and not simply to save taxes.
“(Schedule this meeting) before selling the crops and livestock and before paying the expenses,” he suggested.
Keeping current with accounting records through the year can tell ag business owners if they are on target for achieving operational plans.
“(Staying current) lets owners know if they need to accelerate income or defer income to hit the target,” Guido van der Hoeven, extension specialist at North Carolina Cooperative Extension, said. “Likewise it will show the potential to pre-pay expenses near the close of the tax year, which has the same effect as deferring income.”
Understanding the intricacies of federal and state tax laws of agricultural business can maximize deductions and avoid hefty penalties.
Not all livestock sales are the same. The Internal Revenue Code differentiates between the sale of marketing animals and culled breeding animals.
“Sales of animals raised for sale or purchased for resale and market sales are reported on Schedule F. Net income from market sales are subject to ordinary income tax and self-employment tax,” Pierce explained.
Conversely, the sale of animals used in draft, breeding or for dairy purposes are considered cull sales and are reported on Form 4797.
“Gains from cull sales are not subject to self-employment tax. The sales price that is more than the original cost is subject to capital gains treatment, a more favorable tax rate,” he added.
Documenting sales or trades: Acquiring equipment through trade or a “no-money” down situation can cause tax issues. “When no money changes hands, the farm records may not show the tax preparer that a new item was bought or that a trade occurred,” he explained.
Classification of farm workers: If you exercise direction or control over workers, they should be classified as employees and that requires proper documentation to establish eligibility to work in the United States .Late or improperly filed documents and taxes carry hefty fines.
“Withhold income taxes, social security, Medicare and any state taxes. File the appropriate forms on time and deposit employment taxes correctly and timely,” Pierce cautioned.
Take advantage of Farm Income Averaging. Ag enterprise owners can take advantage of the Farm Income Averaging, which allows farmers to reduce the tax rate paid on farm income, including the sale of cull livestock.
“This falls under Internal Revenue Code 301 and is also available to fishermen,” van der Hoeven said.
Pierce points out that Farm Income Tax Averaging can be filed or changed for the three previous years through an amendment to one’s tax return.
Retirement planning reduces tax liability
Saving for retirement is not often considered by farmers. In many cases farm profits are reinvested in land and equipment or are needed for living expenses. However, retirement savings can reduce federal and state income tax as an “above the line” deduction.
“The deductible contribution to a retirement plan such as an IRA or a SIMPLE or SEP-IRA is subtracted from the total amount of net income reported on an individual’s income tax return, generally lines 7-21 on IRS Form 1040,” van der Hoeven said.
As part of the “adjustments” these contributions are part of the Adjusted Gross Income (AGI) calculation. Once the contribution is made, any returns over time are not included in taxable income until such time as the taxpayer begins to withdraw from the account. Therefore the account grows without tax implications.
On the other hand, ROTH contributions are made “after tax,” meaning there is not a tax deduction in the current year.
“Once the taxpayer (farmer) has owned the account for the requisite period of time and is over 59.5 years of age, withdrawals can be made entirely income tax free,” he explained.
There are other rules that allow for specific tax-free withdrawals as well, for example $10,000 for down payment on a house; a tax professional can provide details.
Learn the tax code
Tax laws are subject to change and staying current with the intricate details is critical. Professional tax preparers help business owners navigate tax codes and business owners can also get educated through seminars hosted by local cooperative extension offices.
“Look for a meeting or one-day seminar near you. The two-day Income Tax Seminars are geared toward tax preparers,” Pierce said.
In addition to on-site training, Pierce and van der Hoeven recommend several resources available online:
- IRS Publication 225, The Farmers Tax Guide: This publication is reviewed annually by a committee of Extension income tax and farm management specialists with the IRS staff who write the various Pub 225 chapters. http://www.irs.gov/pub/irs-pdf/p225.pdf
- Center for Agricultural Law and Taxation at Iowa State is another source available for information regarding taxation. http://www.calt.iastate.edu/
- The Tax Guide for Owners and Operators of Small and Medium Sized Farms is a free resource available at http://www.ruraltax.org.
- The USDA publication Forest Landowners’ Guide to the Federal Income Tax is available at http://www.timbertax.org and at http://www.srs.fs.usda.gov/pubs/42921.
- Rural Tax Education at http://www.ruraltax.org and the National Timber Tax Website at http://www.timbertax.org.
These websites target tax professionals but are written in layman’s language. They cover various topics common to farmers, ranchers, and timberland owners and provide examples. http://Ruraltax.org also has completed sample farm tax returns. Some articles and examples are dated, but are not obsolete.
The IRS has several Audit Technique Guides for agriculture available online. These guides are for use by IRS employees in conducting farm audits and provide information to farmers, ranchers and tax practitioners. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Farmers-ATG
Delaying federal, state and local tax requirements can be costly. “Remember, ‘help me’ is much cheaper than ‘fix me,’ especially when engaging attorneys and accountants,” van der Hoeven concluded.
Cover and all images by Askold Romanov/istock