A common misconception in farm estate and succession planning is that an estate plan is only used after an individual passes away, when in fact, a comprehensive estate plan considers long-term care needs, health care directives, and more. The October Ag Decision Maker article and replay of our recent Women Managing Farmland webinar provides further insight on End-of-Life Taxes and Expenses, both provided by by Kitt Tovar Jensen, staff attorney for the Center for Agricultural Law and Taxation and Beginning Farmer Center coordinator.
Market Facilitation Payments (MFP), Coronavirus Food Assistance Program (CFAP 1 & CFAP 2), Paycheck Protection Program (PPP), Syngenta payments, ARC/PLC payments, crop insurance, etc. have pumped close to $40 billion into the US farm economy in 2020. If you are thinking of deferring any of these government payments, only crop insurance may offer the possibility of deferral. In February of 2020, the USDA was predicting a reduction in US farm income, but now is predicting growth in farm income, up to $115 billion.
This increase in government income could cause some unexpected tax consequences for some farmers this year. Even though crop and livestock prices were low for much of the year, they have now improved and coupled with government payments, farm income is looking better than expected.
If you happen to be in the group that is having a good year and may be better than expected, what can you do to manage your income and income taxes? Here are a few tips that you may use to manage your income.
Prepay expenses: This only works for cash basis taxpayers, not accrual. Some examples that you may prepay are seed, fertilizer, chemicals, feed, up to 12 months land rent that is coming due and any accrued business interest. You must have a business reason for doing so, such as to lock in a price or to insure supply. Tax avoidance is not a good business reason.
Defer income: Using deferred payment contracts for grain sales gives you a lot of flexibility. If you like the price today, you can lock the price in, but take the payment in 2021. The added flexibility is that if you are a cash basis taxpayer and find that you needed the income in 2020, you can pull the contract back into 2020 from 2021 and report the income in 2020, even though you will not receive the cash until 2021. There is a catch, you must pull back a full contract, you cannot pull back a portion of a contract. To have added flexibility you should have multiple smaller contracts and not just one large one. This allows you to have a better chance at managing your income to a level that you want. The added bonus is that this decision can be made after the end of the year.
Crop insurance also may be deferred if the payment received is due to crop damage and not price loss and you normally would have sold the majority of the crop the following year. Again, this does not work for accrual taxpayers.
Depreciation: There are several options for determining how much depreciation you want to take on new asset purchases. If you want to use accelerated methods you have available Section 179 and bonus depreciation. For 2020, the maximum Section 179 is $1,040,000. Farm machinery, grain bins, solar grids, breeding livestock, confinement buildings and field tile all qualify for Section 179. They have to be used more than 50% in the business of farming and it is an asset-by-asset decision. Section 179 cannot create a net operating loss. If you take more than allowed, the remainder will carry over to the following year. The good news is that unlike in previous years, Iowa now couples with the federal rules.
Bonus depreciation is another accelerated method of depreciation. Unlike Section 179 where you choose how many dollars you expense, with bonus depreciation, it is all or none. You expense either the full purchase price or none of it. It can be used on new or used assets and can be used on 20-year property, such as machine sheds. Bonus depreciation is a class-by-class decision. New machinery is a class life 5, so if you decide to use bonus depreciation on a new machinery purchase, all new machinery you purchased will have to use bonus depreciation. Bonus depreciation can create a net operating loss, unlike Section 179. Iowa did not couple with the federal rules on bonus depreciation, so you may reduce federal income, but not Iowa income.
Bonus depreciation also can be used by land owners receiving cash rent.
Retirement plans: Funding retirement plans will reduce federal income taxes, but not self-employment tax. Some retirement plans to consider may be traditional IRAs, 401Ks, Simplified Employee Pension Plan (SEP), Solo 401K, etc.
Charitable giving: The standard deduction for married filing jointly is $24,800 in 2020. You have to exceed this amount with your itemized deductions before it pays you to itemize. Gifting to charities is one of the itemized deductions, but many farmers do not exceed the standard deduction so their charitable giving does not create a tax deduction. Gifting grain to your favorite charity is a much better option. If you sold the grain and then gifted money to your charity, you would have to pay federal, state and self-employment taxes on the income. When you gift the grain directly to the charity, you do not get a charitable deduction, but also have no income to report and avoid the tax consequences. Ownership of the grain must be transferred to the charity before it is sold. Someone from the charity then makes the arrangement to sell the grain.
College savings plans: Contributing to 529 plans can save Iowa income taxes, but not federal taxes. A single person can contribute $3,439 per beneficiary in 2020. A husband and wife could contribute twice that amount. When the money is withdrawn and used for eligible education expenses, it is not taxed.
These are just some of the ways you can manage taxable income, but everyone’s situation is different. It is advisable to contact your personal tax preparer to determine what is best for your tax situation.
While in-person events remain on hold, ISU Extension and Outreach, including Ag Decision Maker, remains committed to serving Iowans. A few resources are included below, and more will be added as needed
The Tax Cuts and Jobs Act (TCJA) was signed into law December 22, 2017. Among many changes, it created new tax brackets for 2018 thru 2025. It also eliminated the deduction for personal exemptions and raised the standard deduction in 2019 to $12,200 for single fliers, $24,400 for married filing jointly and $18,350 for head of households. Keep in mind that most of the changes in TCJA end in 2025 and move back to pre-2018 tax law.
Section 179 Expense election was one of the changes that was made permanent. In 2019, this is now $1,020,000 and the phase-out starts at $2,550,000. On Iowa returns, the maximum amount is $100,000 and the phase-out starts at $400,000. In 2020, Iowa couples with the Federal amounts.
One of the other major changes in the TCJA was the repeal of like-kind exchange treatment for traded personal property. Under old law when a farmer traded machinery, the farmer depreciated the difference paid plus any remaining basis on the item traded in and no taxes were due. Under TCJA when a farmer trades machinery, the trade is considered a sale in the amount the dealer allowed for the trade-in, triggering ordinary taxable gain, and the farmer gets to depreciate the full purchase price of the machinery received. If the farmer does not want to pay tax on the gain of the trade-in, they are forced to use Section 179 or bonus depreciation to offset the taxable gain. Iowa did not couple with the Federal change in 2018, but maintained the old like-kind exchange rules. In 2019, for Iowa returns, farmers may use the old rule for like-kind exchanges or use the new Federal rule. In 2020, Iowa will couple with the Federal rule.
If farmers are forced to use Section 179 or bonus depreciation to offset gains from trading machinery, there can be other consequences. Excessive accelerated methods of depreciation reduce net Schedule F income, possibly taking it down to $0 or maybe even a negative situation. IRA and other retirement plan contributions are based on earned income (Schedule F). The deduction for self-employed health insurance is based on Schedule F net income. Contributions for self-employment tax are based on Schedule F net income. Reducing Schedule F income affects money available for retirement planning and other “above the line” deductions taken on the 1040. Also new in 2018 was the new “post card” 1040 Form that also had multiple schedules attached to it. After numerous complaints, there is another new 1040 Form for 2019. This one is a combination of the old 1040 and the 1040 from 2018. Maybe eventually they will get it right. I am not sure I can stand more simplification in our tax code.
Contributed by Charles Brown, Farm Management Specialist, Iowa State University Extension and Outreach, email@example.com, 641-673-5841
2014 has ended, but that doesn’t mean that some things can’t be done to increase or decrease taxable farm income. Again, late in the year Congress passed legislation that affected 2014 taxable income. Section 179 Expense Election and bonus depreciation were extended for 2014, but 2014 only. In 2015, the Section 179 Expense Election is back to $25,000 with phase-out starting at $200,000 of qualifying assets and bonus depreciation is gone.
For 2014, the Section 179 Expense Election is $500,000 with the phase-out starting at $2,000,000 of qualifying new or used asset purchases. Section 179 can generally be used on 15-year property or less, which would include farm drainage tile, single purpose ag buildings (confinement buildings), grain bins, machinery, breeding livestock and many farm pickups. You can choose any amount from $0 to $500,000 to be used as a fast write-off in the year of purchase of a single asset or multiple assets, but the aggregate total can’t exceed $500,000. Section 179 can be used on the cash difference paid for the asset. Section 179 must be reduced dollar for dollar for every $1 spent on qualifying assets exceeding $2,000,000. Section 179 reduces both Federal and Iowa taxable income and can reduce business and wage income to $0, but not below $0.
Bonus depreciation can only be used on new, not previously used, asset purchases. Fifty percent of the cash purchase price plus the basis left on any trade-ins can be used in the first year of purchase to reduce Federal taxable income. Iowa does not allow bonus depreciation, so you may reduce your Federal income tax to $0, but could still get hit with a sizeable Iowa income tax. Unlike Section 179, bonus depreciation can create a net operating loss. Also there is no phase-out for the bonus depreciation.
You can use both Section 179 and bonus depreciation on the same asset, but must first use Section 179 and then use bonus on the remainder. For example; confinement building costing $1,000,000, the first year depreciation could be Section 179 of $500,000, bonus depreciation of $250,000 (50 percent of $1,000,000 – $500,000) plus $18,750 (7.5 percent x remaining $250,000) of MACRS depreciation. On the Federal income tax return the total depreciation would be $768,750.
What if you had purchased assets in 2014, but not knowing if and when Section 179 and bonus depreciation would be extended you had deferred some of your grain income to 2015 to keep your taxable income down for 2014? If you are a cash basis taxpayer and have deferred payment contracts, you can pull some or all of those contracts back into 2014 and declare the income for 2014 instead of 2015. It has to be a full contract, you can’t pull back part of the income on a contract.
At this time, we don’t know if Section 179 and/or bonus depreciation will be extended again for 2015, so if you have the capital purchases in 2014 to use the Section 179 and/or bonus, you may want to raise your income in 2014 to take advantage of the accelerated methods of depreciation.
Another option that can be applied after the end of the year is whether or not to expense fertilizer and lime costs or amortize them over a period of years. Expensing them at the time of purchase would decrease taxable income and amortizing them over a period of years would increase taxable income for 2014.
As always, visit with you tax preparer to see what your options are, even though 2014 has ended there are certain tax planning strategies that can still be applied.