Like a car needs scheduled maintenance, your ability to prepare year-end taxes probably needs a tuneup, too. Fortunately, you won't see major changes in the tax codes this year, says Neil Harl, Iowa State University agricultural lawyer and economist.
But there are some considerations you should keep in mind when you begin preparing federal and state taxes for this year, Harl says.
HERE ARE SOME OF THE MAJOR AREAS TO WATCH:
Health Savings Accounts (HSAs): Created by the passage of the Medicare Prescription Drug Improvement & Modernization Act of 2003, HSAs offer participants tax benefits that went into effect on Jan. 1.
The big benefit of HSAs is that premiums are deductible from your taxes as long as they're within the “limits” of the plan, says Harl. Those limits relate to the premiums paid, deductible levels allowed, as well as what amounts are allowed for out-of-pocket expenses for qualified medical purposes described under your plan.
Also, the pretax dollars you opt to contribute to your HSA account aren't taxable when distributions are made to pay for acceptable or qualified medical purposes.
“It's important that producers enrolled in HSAs sit down with tax advisers and perhaps insurance brokers to closely examine the rules on coverage and premiums and how those relate back to tax deductions,” says Harl. “Generally, you can reduce your taxable income up to the level of your deductible.”
Expense Method Depreciation: The Internal Revenue Service (IRS) has issued regulations allowing a “late election” on an amended return for “expense method depreciation,” according to Harl.
“This had been discussed by the IRS in committee reports in the 2003 Tax Act; however, it was not included in the tax legislation,” says Harl. “Consequently, the IRS issued regulations allowing a late election.”
This is particularly important, adds Harl, because the expense method depreciation amount totals $102,000 for 2004. That compares to $100,000 in 2003 and just $25,000 in 2002.
“It would be very prudent for producers to discuss this matter with their tax adviser for another reason — some states have not adopted the increased amount,” he says. “This can complicate things because it will likely require taxpayers to generate two depreciation schedules: one for state purposes and one for federal.”
The depreciation allowance, says Harl, is for “purchased property,” and special rules apply for landlords — namely, they must be engaged in a trade or business and meet additional tests if they're a “noncorporate lessor.” Cash-rent lease landlords aren't eligible to deduct expense method depreciation on such things as fences, tile lines and grain bins.
However, if landlords are in a share-rent lease situation and “meaningfully participate” in the farming operation, then they can use this depreciation allowance.
Bonus Depreciation: In the November 2003 issue of The Corn And Soybean Digest (for more details, please read “Uncle Sam's Tax Tips,” at www.cornandsoybeandigest.com), it was reported that new property placed into service after May 5, 2003, was eligible for a 50% bonus depreciation.
That higher bonus was available for eligible property placed in service before Jan. 1, 2005, provided there was no binding contract in effect before May 6, 2003. The bonus depreciation allowance included up to 20-year property if it was new and the original use commenced with the taxpayer.
Some producers may have claimed this bonus depreciation allowance only on the cash boot paid on a trade.
“While larger producers tend to use the ‘bonus depreciation’ more than the smaller to mid-size farm operations who may rely more on Section 179 expense method depreciation, it's still possible for producers to go back and pick up that bonus depreciation on the entire adjusted basis,” says Harl. “This is definitely something to discuss with your tax adviser.”
For more information about tax law, the IRS offers its yearly Farmer's Tax Guide, Publication 225 online, which can be accessed at its Web site: www.irs.gov. In the “Search Forms and Publications” column heading, type in Publication 225.
OTHER TAX ISSUES
Based on other IRS rulings and court cases in a few states, Harl also strongly recommends that producers discuss the following issues with their tax adviser:
Conservation Reserve Program (CRP) Payment: There are a few things to keep in mind about how the IRS views such payments — especially to retirees or investors — and on whether or not they're subject to the self-employment (SE) tax.
“Basically, if the IRS determines there is a direct connection or ‘nexus’ between the land under the CRP and the actual farming business, then you're obligated to pay the 15.3% self-employment tax. And that's been true for a long time,” says Harl.
A 2003 ruling implied that even retired landowners and investors had to pay SE tax on CRP payments. That ruling is under review by IRS.
The Mizell Case Problem: “Problems have arisen in a few cases where farmland was rented to a family general partnership or other entity,” says Harl. “The IRS has been successful in asserting SE tax liability, especially where the rental was not a fair market rental.
“The key point here is that reasonable, fair-market rates aren't likely to be subjected to the self-employment tax. Unfortunately, this remains a bit of a gray area until things settle out in some key court cases.”
Hedging or Trading Accounts: If you're involved with hedging or commodity trading accounts, Harl suggests reviewing them with your tax adviser to make sure they're held by the proper business entity.
“There have been cases where producers have formed a C corporation and kept their futures trading accounts in a sole proprietorship without transferring them to the new business entity,” says Harl. “This can be easily missed when making changes in your business structure; however, the IRS says it's a no-no and considers the commodity trade to be speculation.”
That means gains and losses are capital gains and capital losses. For hedges, gains and losses are treated just like gains and losses on the actual commodity.
New Law: In late September, the Working Families Tax Relief Act of 2004 extended, for various periods, expiring provisions on the child tax credit, marriage penalty relief, the new 10% tax bracket, alternative minimum tax relief and several other provisions.