This article discusses two sides of the tax planning. First, the situation some farmers may discover is that more income is desired to reach the long-run taxable income target for the business. Second, a farm or ranch may have had a better-than-average year and the goal is to reduce taxable income to reach the long-run target. Additionally, it is important to keep in mind that tax planning for farmers and livestock producers is a year-long management activity.
Increasing Taxable Income for 2018
1. With the Tax Cuts and Jobs Act of 2017 passage in December 2017, the standard deduction amount was increased. For those filing as married filing jointly, the standard deduction is $24,000 and for those filing as single it is $12,000. Farmers will want to be sure to generate Adjusted Gross Income of at least these amounts depending upon filing status. The standard deduction amount represents tax-free income and if one does not use them, the tax benefit is lost and cannot be carried forward.
2. If possible, farmers need to consider selling grain and livestock this year instead of in 2019. This puts income into 2018. Beef cattle producers need to consider both animal weights and their general long-term marketing plan; delaying livestock sales below or above target market weight may reduce enterprise profits.
3. An option to increase farm incomes in 2018 is to postpone paying 2018 expenses (usually purchases in the last couple months of the year) until 2019. Delaying the payment of expenses such as: chemicals, lime, fertilizer, seed and fuel increases taxable income in 2018.
4. If the farm has incurred a large repair, such as an engine overhaul, consider capitalizing the repair and depreciating the repair. Similarly, farmers may amortize fertilizer and soil amendments such as lime over a period of time instead of electing to immediately expense these costs by reporting the amounts on their business tax form which commonly is Schedule F: Profit or Loss from Farming.
5. Farmers might want to “slow down” depreciation by using the alternate depreciable life of an asset. For example, a $100,000 new tractor in 2018 has a MACRS five-year depreciable life at 200 percent declining balance, choosing to use the alternate depreciable life and straight-line depreciation can increase taxable income by $15,000 [$20,000 MACRS GDS depreciation - $5,000 MACRS ADS depreciation]. To accomplish this farmers must not use bonus depreciation or the expensing election which is discussed below.
Decreasing Taxable Income in 2018
For some farmers and ranchers, 2018 may have been a profitable year from an income tax perspective. Therefore, the tax planning focus may be to lower taxable income. There are several strategies to do so. Some are work prior to year-end and some are useful after the year is complete.
Prior to year-end actions to consider:
1. Farmers and ranchers might consider delaying sales until 2019. Generally, this can be accomplished in one of two ways. First, simply hold onto the production and sell after the first of the year if the farm uses the cash-method of accounting. Second, if the farmer is satisfied with a price being offered now, sell the commodity using a deferred contract with payment of a specified commodity after Jan. 1, 2019, at a specified price per unit of the commodity with a clause that prohibits the farmer from receiving payment until the contract date.
2. Another option is to consider pre-paying for inputs to be used in 2019 by purchasing the items before Dec. 31, 2018, if the farmer uses the cash method of accounting. Generally, there is a limitation to how much can be purchased in advance. A rule discussed in the Farmer’s Tax Guide, IRS Publication 225, is 50 percent of historic inputs. Refer to the Farmer’s Tax Guide for additional tax information.
3. Capital asset purchases, such as machinery and equipment, could be purchased and placed into service prior to year-end and be available for post year-end tax planning. However, do so only if this is in the long-term business plan of the farm. In other words, do not let the tax tail wag the business dog (use of the expensing election and bonus depreciation follows in the next section).
Post Year-End Tax Management Strategies
1. The TCJA increased the amount of IRC Section 179 expensing to $1 million with an investment limit of $2.5 million. If farmers and ranchers purchased depreciable assets in 2018, they can make the election to expense all or part of these purchases subject to the rules for Section 179.
2. The TCJA also allows for bonus depreciation of 100 percent for new and used depreciable assets purchased in 2018. The law presumes that farmers and ranchers will use bonus depreciation. Doing so, in some cases, may create a loss which might not be in the best interest of the agricultural business. Producers have the option to elect out of bonus depreciation on a class-by-class basis (for example, elect out for all three-year class life property).
3. Continued contribution to or initial creation of a retirement plan can also reduce income taxes. The plans that do reduce current year income taxes are: traditional IRAs, SEP-IRAs, SIMPLE IRA, and solo 401-Ks. There are rules for when the plan must be established in order for the contribution to be deducted from 2018 income.
Farmers and ranchers may be more interested in non-deductible retirement plans due to their distributions being income tax-free in their retirement years. These plans include Roth IRAs and Roth 401-Ks.
Farmers and ranchers are strongly encouraged to seek professional tax preparation assistance to address areas of tax management for their businesses. Seek competent tax advice from someone who is familiar with agriculture and can explain the applicable tax laws can help farmers and ranchers achieve their goals relative to income and self-employment tax management. Remember the goal of good tax management is not to reduce taxes but to increase after tax net income over the life of the business.