farm income tax update 2014
TRANSCRIPT
Income Tax Update
Presented By
Andy Saltzman, CPAJoe Baker, CPA Glen Birnbaum, CPA, ABV
www.hbcpas.com
2
Agenda
• Depreciation• Deferred Grain Contracts• Prepaid Farm Expenses• Taxation of Easements• CRP and Self Employment Tax• Federal Tax Estimates for Farmers• Farm Income Averaging
www.hbcpas.com
3
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
www.hbcpas.com
4
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
www.hbcpas.com
5
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?
www.hbcpas.com
6
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
www.hbcpas.com
7
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
www.hbcpas.com
8
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.
www.hbcpas.com
9
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
www.hbcpas.com
10
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)
www.hbcpas.com
11
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
www.hbcpas.com
12
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
www.hbcpas.com
13
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
www.hbcpas.com
14
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
www.hbcpas.com
15
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
www.hbcpas.com
16
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.
www.hbcpas.com
17
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
www.hbcpas.com
18
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)
www.hbcpas.com
19
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
www.hbcpas.com
20
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
www.hbcpas.com
21
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
www.hbcpas.com
22
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
www.hbcpas.com
23
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
www.hbcpas.com
24
CRP SE Tax Update Cont.
• Eight Circuit Court of Appeals heard oral arguments in June 2014, so stay tuned
www.hbcpas.com
25
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…
www.hbcpas.com
26
Cash Basis Accounting
• Generally for all other deductions, the deduction must be taken when payment occurs
• Arbitrarily postponing expenses is not allowed
www.hbcpas.com
27
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
www.hbcpas.com
28
Cash Basis Accounting
• Cash Basis Exception #2: Amortize Fertilizer− Previously discussed
www.hbcpas.com
29
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
www.hbcpas.com
30
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
www.hbcpas.com
31
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
www.hbcpas.com
32
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
www.hbcpas.com
33
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
www.hbcpas.com
34
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
www.hbcpas.com
35
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
www.hbcpas.com
36
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
www.hbcpas.com
37
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)
www.hbcpas.com
38
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%
www.hbcpas.com
39
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%
www.hbcpas.com
40
Heinold Banwart, Ltd.
201 Clock Tower Drive, Third Floor
East Peoria, IL 61611
309-694-4251
www.hbcpas.com