Don't scramble - develop a solid tax strategy now
In 1794, American farmers mounted protests against federal taxes on grain. President George Washington promptly crushed the tax rebellion with federal troops.
Today, taxes on farm families are probably much worse. But farmers have learned there are more effective ways to minimize tax bills than to take on federal troops.
Smart farmers now follow a sophisticated strategy of using legal tax breaks to boost after-tax income. But some are still paying too much.
"My hunch is that some probably do pay more than they owe," says Parman Green, farm business management specialist at the University of Missouri.
For these farmers, a last-minute glance at the tax code isn't likely to do the trick. The key to saving taxes is planning. Here's what experts suggest:
- Study the tax code. You can't take advantage of a deduction if you don't know it exists.
- Learn the art of timing. Tax experts say many tax consequences depend on when you do something, such as when you sell your crop. Some other timing decisions involve how you schedule depreciation and the timing of futures and options transactions.
- Learn the art of long-term tax planning. People who get rich look at their taxes two ways - how to minimize them in the current year and how to minimize them over the long-term through a multi-year strategy.
- Avoid trouble with the IRS by doing your taxes correctly. Nothing boosts the tax bite like a bill for back taxes with interest and penalties.
- Keep good records. Good records provide proof of legitimate expenses when the Internal Revenue Service (IRS) comes calling. They also play a vital role in long-range tax planning, such as scheduling deductions for depreciation on tractors, combines, grain bins or other capital expenses.
- Get help from a professional who understands agricultural tax law if you need it. This helps in four ways. Tax pros can help avoid mistakes that could trigger an IRS audit and back taxes with penalties and interest. They can also help find tax breaks to which you're entitled, help craft a long-range tax strategy and help guide farmers through the difficulties of ag tax law.
"Taxes have become quite complicated and specialized," says Green. "And agriculture has its own unique provisions within the tax law."
- Consider federal tax breaks such as individual retirement accounts and medical savings accounts.
- Take steps to lower your estate tax bill. The potential estate tax bill is huge. But much or all of it can be avoided through planning. One trick is to begin giving away portions of your potential estate while you're still living. This reduces the amount of the estate subject to taxation.
If both spouses jointly own a farm, each spouse can give $10,000 of farm or non-farm assets each year to any number of individuals, says Green. For example, if they had five children, each spouse could give each child $10,000 each year. And if all the children were married, the gifts could be doubled to include the children's spouses.
That would reduce the potential estate by $200,000 in just one year. But there's a catch. You can't give away part of the farm and then keep all the income for the part you've given away, Green cautions.
Overall, the benefits of tax planning can add up. They make the good years better and may ensure survival in the bad ones.
"Back in the 1980s, we had a really big financial crisis," says Colorado State University's Dana Hoag, author of Agricultural Crisis in America. "People who studied that period concluded that those who did best were those who cut costs - not those who raised income. Taxes are one way to cut costs."
Lobby For Tax Breaks The federal budget is awash in black ink for a change - and tax cuts are likely regardless of which party takes the White House and Congress. Who will get the tax breaks is the big question. Here's a partial list of proposed tax breaks favored by the American Farm Bureau Federation:
- End the estate tax, which can run as high as 55% of the portion of an estate subject to taxation.
- Make health insurance premiums for self-employed farmers fully deductible - immediately. Under current law, these premiums won't be fully deductible until 2003.
- End capital gains taxes.
- Replace the current income tax code with a system that encourages savings, investment and entrepreneurship. Farm Bureau dislikes the current system because it includes an estate tax that may force families to sell farms, and it includes capital gains taxes that discourage the flow of capital to new ag enterprises.
For more on proposed tax breaks, see the Farm Bureau's Web site: www.fb.org.