Time is nearly up to get 2015 in order
Whether you had a good or a bad year on the farm, December is an important time to manage your 2015 taxes. Look at your records and determine your 2015 income. If your earnings look high, you may want to defer income or pre-pay purchases. If your earnings weren’t so hot, you can take other measures. We asked two farm tax experts to offer advice on steps to take now, before year-end, to minimize your 2015 tax liability.
Joe Koenen is an agricultural business specialist for the Northeast Region of the University of Missouri’s Extension Service in Unionville, Mo. “In December, estimate your income to determine where you’re at,” Koenen said. “Unlike other taxpayers, farmers can still make adjustments. You can use income averaging, and it’s a valuable tool.”
Paul Neiffer, a CPA and a principal at the agribusiness practice of CliftonLarsonAllen in Yakima, Wash, agrees that working up an estimate of your income and expenses to year’s end is the first step. “Then you can determine any additional sales you should make in 2015, or any expenses to pay or equipment to purchase to reach your optimum taxable income number.”
Shift income and expenses to 2015 or 2016
If your estimate shows you will end up with a large taxable income for 2015, consider pre-paying expenses to offset your income. IRS rules state any expenses taken must be for a business reason. “Since the cost of inputs such as seed, chemicals and fertilizer have gone up in recent years, it’s normally not a problem,” Koenen said.
If you experienced good earnings this year on grain, Neiffer said you can sell it this year but not receive payment until 2016, allowing you to defer the income into 2016. On the other hand, if you need to increase 2015 income, you can bring this income into 2015. This must be done on a contract-by-contract basis, he added.
Koenen added that an easy way to defer income is to wait to sell crops or livestock until after the first of the year. Some elevators and livestock sale facilities allow producers to sell in the current year and defer their check until the next year.
Crop insurance payments based on yield losses can be deferred from 2015 to 2016 if your normal business practice is to sell more than 50 percent of your grain in the year after harvest, Neiffer said. “But the portion related to price can’t be deferred, and this year, most crop insurance proceeds relate to price.”
Koenen pointed to a special provision for deferring crop insurance proceeds in a flood or drought year. “If you normally sell your crop in the year following harvest, then you can also defer crop insurance proceeds,” he said. “However, you must be a cash basis taxpayer, and it must be your normal business practice to delay all crop sales to the year following harvest.” If you receive insurance proceeds in the year following the disaster, you have to report the proceeds that year, he added.
Watch for depreciation rules to change
Both experts say the tax code’s Section 179 expensing can be valuable. “Section 179 allows expensing equipment and breeding livestock purchases, although this option could vary depending on whether Congress makes changes to tax law before year-end,” Koenen said.
Section 179 currently limits depreciation to $25,000 but both Koenen and Neiffer expect Congress to renew it at $500,000 for 2015 and possibly 2016. “We may not know the final amount until late December,” Neiffer said.
Koenen added that farmers get penalized under current depreciation rules. If you purchase more than 50 percent of your depreciable purchases in the last quarter, the depreciation you can take is cut drastically. “Section 179 allows you to determine your income for the year and then decide whether to take advantage of the option,” he said.
Recent years brought positive earnings for many farmers, prompting booming equipment purchases toward year-end. “Buying equipment just to save on income taxes is a poor choice,” Neiffer said. “But if you need to purchase equipment, then buying by year-end will save on your 2015 taxes.”
Koenen agreed, saying you should buy equipment only when you need to upgrade or replace it. Generally, you don’t know your income or ability to purchase machinery until the end of the tax year draws near.
Neiffer added that you can also depreciate things like new buildings, irrigation equipment and conservation investments. If the 50 percent bonus depreciation comes back, you can deduct half of any new items, plus take regular depreciation on the remainder. The asset must be placed in service before year-end to qualify.
“For example, if a farmer spends $50,000 on a new machine shed before year-end, but the machine shed is not complete until 2016, then none of the $50,000 is allowed as a deduction in 2015,” Neiffer said.
Koenen and Neiffer explained how you can depreciate various investments. Most of these improvements must be purchased by the end of the year.
• You can depreciate farm buildings over a 20 year period. But single purpose livestock structures such as a hog barn or dairy parlor can only be depreciated over 10 years. They are not eligible for Section 179 expense. Koenen added that machine sheds and hay barns may qualify for first-year bonus depreciation, and Congress may extend first-year bonus depreciation by year-end.
• Irrigation systems can be depreciated over seven or 15 years.
• Soil and water conservation items can be expensed if you qualify as a farmer—if two-thirds of your gross income comes from farming—otherwise they must be capitalized and depreciated.
• Improvements on rented land can be expensed or depreciated. However, if you later lose that land, you may have to recapture some depreciation or any Section 179 expense taken.
Follow employee rules
“This is an area where I see farmers mess up a lot,” Koenen said. “The IRS states that employees include those who use your tools and machinery and are paid on a time basis such as per hour, day or month. Independent contractors have their own tools and machinery and are paid by the job, such as per square foot of dirt moved, per acre or per bale. If you pay an employee more than $250 in a year, you must withhold employee taxes.”
Here’s where Koenen sees problems. For example, you don’t think you’ll pay that much to someone early in the year so you incorrectly call them an independent contractor and don’t withhold taxes. In another situation, you hire someone to build fence but the fence-builder uses your tools and equipment; you incorrectly call him an independent contractor.
Neiffer expands on the need to determine if anyone performing services for you is an employee or an independent contractor. “There are many rules on this,” he said. “Hiring the local co-op to spray your field is not an employee situation. However, if you hire an individual to work for you and you have control over the worker’s actions, then he/she is an employee.”
Koenen and Neiffer warned that if you break this rule, you may have to pay backup withholding of 30 percent of the employee’s pay. “Fines start at under $100, but go up if you’re caught a second time,” Koenen said.
Neiffer also advised farmers to comply with the Affordable Care Act. “Essentially, if you are providing individual health insurance to more than one employee or reimbursing health insurance for more than one employee and it is not a qualified ACA group policy, you will likely be subject to a $100 per day per employee penalty.”
Line up records and tax experts now
December is the time to get your records in order. As Koenen said, “Estimating taxes requires up-to-date records. You will need all year-to-date income, expenses, capital sales and purchases.”
Neiffer added that most farmers use some type of computerized accounting system, which is great. He suggests that you keep records for at least four to seven years.
Both Neiffer and Koenen feel strongly that farmers and ranchers should seek help from a tax professional, and it helps if the expert specializes in agriculture. “Tax laws continue to change, and without appropriate knowledge and software, it would be extremely difficult for any farmer to prepare an accurate tax return,” Neiffer said.
“They have the expertise and computer programs to make tax estimates fast and relatively simple,” Koenen said. “They can also help determine your best course of action going forward.” Some Extension Ag Business Specialists like Koenen can help with tax estimates.
Is your tax bite getting bigger?
For the most part, federal tax rates remained constant in recent years. However, as our experts point out, farmers and ranchers generally pay more taxes in good years and less in poor years.
“For most crop growers, today’s lower crop prices mean income from past years will start to get taxed in 2015 or 2016,” Neiffer said. “Certainly most cattle ranchers will have higher income taxes for 2015.”
Koenen said that tax rules haven’t changed much, with one exception: “Capital gains rates were raised somewhat on higher income levels in the last few years. This impacts farmers since you have more capital assets than many individuals and businesses, including machinery, land and breeding livestock.”
Neiffer took a stab at predicting tax law changes in the future. “2016 is an election year, so nothing will happen in the coming year, but major tax reform may arrive in 2017,” he said. “Positive and negative changes may be in store for farmers. On the plus side, Section 179 may be set at $1 million permanently, and indexed to inflation. On the negative side, cash accounting for some farmers may no longer be available and depreciation might last longer.”
Here’s your best tax advice
Neiffer and Koenen summarize their best nuggets of tax advice for ag producers.
“Never not pay any income taxes,” Neiffer said. “Many farmers try to get to zero and give up many tax-free items, or don’t take advantage of standard deductions and exemptions.” Farmers need to track how your deferred tax liability might affect you in the future, he added.
Koenen stressed that it’s critical to estimate your earnings toward the end of the tax year so you can make adjustments if necessary. “After the year is over, it’s too late to complain,” he said. “Paying taxes isn’t all bad—it means you had a good year!”
This article provides general suggestions, but you must follow specific IRS rules to avoid penalties. Consult a professional tax preparer for advice on your situation. For more information, search the Internet for “IRS Publication 225, the Farmer’s Tax Guide,” and look for the 2015 version. Also, contact Extension about tax workshops and information.