Download - Farm income tax update 2014
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Agenda
• Depreciation• Deferred Grain Contracts• Prepaid Farm Expenses• Taxation of Easements• CRP and Self Employment Tax• Federal Tax Estimates for Farmers• Farm Income Averaging
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Depreciation Update
• 50% Bonus Depreciation expired at 12/31/13 (new equipment)
• Sec. 179 limitation is currently at $25,000 (new and used equipment)– Reduced when property placed in service
exceeds $200,000
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Depreciation Update
• U.S. House has passed a bill in June to make
permanent the $500,000 section 179 limit
• Senate not likely to vote until after November
election
• President has promised to veto the bill
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How Do We Plan for This Uncertainty?
• Bill could be passed on January 1, 2015 and retroactively apply to 2014 year
• How do we make sure that income is “low enough” if only $25,000 section 179, but still allow for flexibility if section 179 limit is raised?
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Tax Tip #1
• When selling grain in the current year for next year payment, be sure to use multiple contracts to allow income to be “pulled” into the 2014 tax year if needed
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Deferred Payment Grain Contracts Background
• Sell grain in the fall (title has transferred)
• Wait to take check on January 1st
• Not income until the following year
• Installment sale contract
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Deferred Payment Grain Contracts Strategy
• Can elect out of installment sale
• Thus, contract by contract, a farmer may make an election out of the deferred treatment
• Example: You have a $250,000 grain contract. If section 179 is passed, then you offset the increased depreciation expense with this grain income.
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Tax Tip #2 Amortizing Fertilizer Expense
• If a higher Sect. 179 limit is passed:– It may be beneficial to amortize the cost of
fertilizer paid for during the year, instead of deducting it all in the current year
– Amount used each year would be deductible; usually over 12 months, but may want to consult an agronomist
– Works similar to deferred payment grain contract
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Prepaid Farm Expenses
• Definition: Items that are paid for in the year before
the year in which they are consumed or used
• Specifically includes:– Feed, seed, fertilizer and other similar farm supplies– Does NOT include rent or interest expense– Spring-applied fertilizer and chemicals and seed paid
for in the prior year (paid for, but not yet applied)
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Prepaid Farm Expenses Cont.
• Generally deductible in the year of payment for
cash basis taxpayers (including partnerships and
S corps) if three tests are met:
– Test 1: Payment must be for actual purchase (i.e.
enforceable sale contract)• Specific quantities of specific item(s)• No right to refund• Should not substitute for different items
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Prepaid Farm Expenses Cont.
– Test 2: Needs to be for a business purpose and not merely for tax avoidance• Discount/fixing maximum price• Securing adequate supply
– Test 3: Deduction will not result in a material distortion of income• Quantity purchased should be comparable to
quantity used in the next year• Customary business practice
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Prepaid Farm Expenses Cont.
• Limited to 50% of deductible non-prepaid farm expenses unless:
– Due to change in business operation – Due to extraordinary circumstances– Prepaid farm expenses for last three years total
less than 50% of deductible non-prepaid farm expenses for last three years
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Prepaid Farm Expenses Cont.
• Example:
– Total farm expenses, including depreciation on Sch F, of $1 million
– $600,000 represents deductible non-prepaid items, such as depreciation, chemicals, fertilizer, interest, etc.
– $400,000 represents prepaid chemicals, fertilizer and seed to be applied next year
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Prepaid Farm Expenses Cont.
• Is any of the $400,000 limited?– Non-prepaid expenses are $600,000
– 50% of $600,000 is $300,000– Therefore, prepaid expenses of $400,000 are
limited to only $300,000– $100,000 carried over to next year
– Limit is NOT 50% of $1 million– Note: May be able to avoid limit if under
50% limit for prior three years
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Prepaid Farm Expenses Cont.
• Example of prior three years test: Prepaid Non-prepaid
Prior Year 1 $275,000 $625,000Prior Year 2 $300,000 $650,000Prior Year 3 $325,000 $675,000 Total $900,000 $1,950,000
(46% of non-prepaid)
Since prepaid expenses total less than 50% of non-prepaid expenses for the prior three years, the current year 50% limit does not apply.
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Taxation of Easements
• Payments for easements can produce:– Reductions to basis in land– Long-term or short-term capital gains– Ordinary income
• Usually have all of the above on the same transaction
• Can be eligible for like-kind exchange
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Taxation of Easements Cont.
• Perpetual easement with significant rights retained, such as the ability to farm the ground:– Basis in land affected by the easement is
first reduced to $0 by proceeds– Any additional proceeds are treated as
gain reported on Form 4797 (usually L/T capital gain)
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Taxation of Easements Cont.
• Perpetual easement with no rights retained is treated as a sale of the underlying affected land– Essentially the same treatment as when
rights are retained– It is possible for a loss to be recognized if
basis in affected land is greater than proceeds
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Taxation of Easements Cont.
• Easements that are of specific duration (or not perpetual) run the risk of being treated as ordinary (lease) income by IRS
• Temporary easements are rental income
• Crop damage payments are generally ordinary income
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Taxation of Easements Cont.
• It is possible to reduce the entire basis of property by damage proceeds if the entire property is affected by the easement (severance damages)
– Example: power lines across the middle of property that was designed for development
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CRP SE Tax Update
• Before 2003, IRS stated that if taxpayer materially participated in a farming operation, CRP payments were subject to self employment tax
• In 2003, IRS took the position that merely signing the CRP contract resulted in the taxpayer being engaged in the trade or business of farming
• In 2008, Congress precluded CRP payments from SE tax for taxpayers receiving Social Security retirement or disability benefits
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CRP SE Tax Update Cont.
• In 2013, U.S. Tax Court case decided in favor of IRS in assessing SE tax on CRP payments on land inherited by an out-of-state landlord– If taxpayer cash rented the land, no SE tax
would apply– Ignored prior court cases that stated the
existence of a trade or business is determined by facts and circumstances
– Note that active farmers will generally automatically be subject to SE tax
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CRP SE Tax Update Cont.
• Eight Circuit Court of Appeals heard oral arguments in June 2014, so stay tuned
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Cash Basis Accounting
• Can you pay expenses this fall and – if later income is found to be too low – just postpone the deduction until 2015?
• Not really…
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Cash Basis Accounting
• Generally for all other deductions, the deduction must be taken when payment occurs
• Arbitrarily postponing expenses is not allowed
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Cash Basis Accounting
• Cash Basis Exception #1:− You can begin depreciating equipment
when you legally own the asset and it is available for use, regardless of when payment occurs
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Cash Basis Accounting
• Cash Basis Exception #2: Amortize Fertilizer− Previously discussed
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Fed Tax Estimates for Farmers
• March 1st deadline for filing and paying tax− Can be difficult to have all K-1s ready and file the
return by March 1st
− Solution?− Pay a January 15th tax estimate− Pay tax on April 15th and incur interest charge
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Fed Tax Estimates for Farmers
• Be aware you are only charged interest from January 15th to April 15th, if you elect to pay late
• Federal interest rates are generally very low, although they are nondeductible
• Interest figured on the smaller of:− 100% of prior year tax or − 67% of current year tax
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Fed Tax Estimates for Farmers
• Current Year Tax x 67% x 90/365 x 3%
• $100 in tax owed = $.50 penalty (one-half of one percent)
• About a 2% annual interest rate (keep in mind, nondeductible though)
• $100,000 in tax owed = $500 interest charge
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Farm Income Averaging
• All net farm income is eligible for farm income averaging, even if the taxpayer does not qualify as a farmer for the March 1st filing date
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Farm Income Averaging
• Income that qualifies for farm income averaging besides Sch F net income:– Gain on sale of equipment or breeding stock (Form 4797)– Wages to a shareholder from an S corporation engaged in
farming– Pass through income from farming from partnerships and
S corporations– Crop share income, provided there is a written agreement
entered into before tenant begins significant activities
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Farm Income Averaging
• Income that does NOT qualify for farm income averaging:– Farm income passed through from a trust– Gain from the sale of land
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Farm Income Averaging
• Allows a farmer to take current year income, which is being taxed at higher rates, and instead tax that income at the rates in effect for the prior three years
• With rates being increased starting in 2013, make sure this is being computed
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Farm Income Averaging
• Farm income averaging:– $150,000 of farm income in 2014
– Take $150,000 / 3 = $50,000– The $50,000 is then taxed at the marginal rate in
effect for– 2013– 2012– 2011
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Farm Income Averaging
• The income on which self-employment tax is computed is based upon the current years income and does NOT get averaged– In the prior example, SE tax would be based
upon the $150,000 ($150,000 x 92.35% x 15.3% = $21,194)
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Farm Income Averaging
Married filing joint tax rates for 2014:
Taxable Income Marginal Rate $0 - $18,150 10%
$18,151 - $73,800 15%
$73,801 - $148,850 25%
$148,851 - $226,850 28%
$226,851 - $405,100 33%
$405,101 - $457,600 35%
$457,601 - 39.6%
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Tax Rate HistoryTop Individual Tax Rates
1980 1990 2000 2011 2014
Ordinary Income
70.0% 28.0% 39.6% 35.0% 43.4%
Capital Gains
28.0% 28.0% 20.0% 15.0% 23.8%
Dividends 70.0% 28.0% 39.6% 15.0% 23.8%
Illinois 2.5% 3.0% 3.0% 5.0% 5.0%