Strong commodity prices should mean higher taxable incomes for you in the 2008 crop year, and tax experts advise taking additional time to maximize tax strategies before the clock strikes midnight on Dec. 31.
“Many producers are seeing record incomes, and income after expenses is bigger than many have ever seen before,” says George Patrick, professor and Extension economist at Purdue University. “They are going to need to manage how they pay taxes, and this year may take more tax planning than normal.”
THE NORMAL WAYS of managing taxable income, like moving grain sales into the next tax year, is one way to transfer income. “But there are substantially more dollars associated with those strategies, and that may mean an additional tax burden,” Patrick says.
“If a producer sold his 2007 crop in the 2008 tax year, and also sold 2008 crop this year, all of a sudden two years of receipts in one year can significantly increase taxable income,” Patrick says.
Producers may want to look at income averaging to even out the tax rates on their income. For instance, at filing time, a producer can choose to have a portion of the current year's farm income taxed at the previous three years' tax rate.
“If, for example, you had a low income in tax years 2005, 2006 and 2007, then had a greater income in 2008, you could elect any portion of the 2008 income to be taxed at the rate of the prior three years,” says Philip Harris, Extension law specialist at the University of Wisconsin.
“That is an important option to keep in mind at the end of the year planning, so instead of moving income into 2009, producers are essentially spreading income back over the previous three tax years,” Harris says.
By pushing income into 2009, a producer loses the 2005 tax year to average income. “That strategy really spreads out thinking about the level of your income in both prior and future years,” Harris says.
Ideally, producers want to have a long-term view of their income from year to year, determine where their average income will fall over a number of years and keep taxable income in that range. “If producers continue to postpone income, that ultimately may mean they will end up in a much higher tax bracket and their tax liability will be greater,” Harris says.
Producers can still defer income into the 2009 tax season by postponing sales or using installment sales. “That means producers need to know where they stand,” Harris says. “They can accelerate expense payments, buy inputs for 2009 and deduct those expenses on the 2008 income tax return.”
Keep in mind that the rules are very clear: You must actually buy something rather than make a general deposit. “You can't go down to the co-op and put $30,000 on your account for items you may need to buy next year. You have to be specific about what the money is being used for, and you must have ownership.” You do not, however, have to have the product physically delivered to your farm.
THERE ARE TWO new provisions for the 2008 tax year.
“Deductions for Section 179 have increased to $250,000, up from $128,000 under the previous rules. That's a substantial increase for farmers who have made a lot of purchases of new machinery,” Harris says. “That is a much larger write-off against 2008 income.”
Another provision, from the economic stimulus package passed earlier this year, is a one-time accelerated depreciation of 2008 purchases. “If a producer purchased a $130,000 tractor in 2008, he can depreciate 50% of the purchase price in 2008, which would generate a $65,000 deduction,” Harris says. “The remaining $65,000 would be claimed during the normal five-year recovery period.”
But keep in mind that this single provision applies only to the 2008 tax year.
For producers who had the misfortune of crop losses and will be receiving disaster assistance or crop insurance payments, “there are many different rules as to how these payments get handled,” Patrick says.
“Many of these payments would get folded into the rest of your tax situation. But it might be that if you have crop insurance proceeds, and a normal practice is to sell your crop in the following year, you would essentially roll that insurance indemnity into 2009,” Patrick says. “That would be the usual situation if income were higher than normal and you wanted to delay recognizing that income.”
STRONG INCOMES ALSO bring back another sound management strategy: retirement programs. Depending on the type of plan, producers can put up to $40,000 into a qualified retirement plan. That money is not taxed now, but would be taxed when it is taken out. However, it immediately would reduce the tax liability in 2008, and provides for additional financial benefits in the future.
“In addition to the tax savings, producers would get some diversification in their investment portfolio,” Patrick says. “So many producers put additional income right back into the operation. But this year, especially with some producers looking at extra funds, it is a perfect opportunity to defer income for retirement, and give you more diversity in your portfolio.”
Rolling sales into the next tax year could snowball and ultimately raise your tax liability, experts say.
“That's where the tax planning can be especially difficult,” Harris says. “Because who really knows if commodity prices will stay at current levels, increase or fall back?”
Ultimately, forging a long-term strategy that tries to minimize the spikes in income can optimize your tax strategy.