Author: Adam Kantrovich

We have now past the midway point for the 2023 calendar year. We are carefully and optimistically watching our crops develop as well as keeping tabs on global events. It has been another wild year with crazy weather and its effects around the country, from areas of drought and high heat, to areas where excessive moisture has produced standing water and flood warnings. The upheaval in Eastern Europe, Russia’s ongoing attempt to take over Ukraine, continues to create a variety of issues around the globe. With all the issues taking place, we are seeing variability and fluctuation in commodity prices, both positive and negative, and we can sometimes get dizzy thinking about all of the “what ifs.” When this happens, we choose not to want to think about it, and it simply creates management decision paralysis. We need to eat this elephant one bite at a time, and possibly request some assistance from the right individuals. Make sure you have the right information to make the best decisions that can be made to prepare for the rest of the season and year. 

This is a good time to take a few steps to ensure you are on the right track for risk mitigation. 

1. Have you scouted your crops to estimate yield, barring any late-season weather-related disasters? Does this match your marketing plan, or do adjustments need to be made? For livestock, do you have the feed necessary on hand/or being produced? Does additional feed need to be purchased? What options are available to lock in prices and supplies that allow for profit?
2. Review your marketing plan and determine if any changes need to be made. Is it time to look at additional hedging or spreads opportunities to help mitigate price/marketing risk?
3. Do you have labor available and can you afford what is needed? Is mechanization required to cut back on labor, and does it pay to do so? 
4. Have you run cash flow estimates for where you believe you will be at the end of the year? Do you need to make adjustments, prepare for tax management strategies before the end of the year, cut back on expenses, increase sales of culls, other inventory to access cash, etc.?

Although the above-mentioned situations are things that we normally think about, we typically don’t give the thought each of those deserves as we get overrun with daily tasks on the farm. However, a mid-year check to mitigate risk may offer the opportunity for the farm or ranch to increase its cash flow. There are a number of resources available to assist farms and ranches in understanding the decisions to be made, and possibly even performing a true analysis of the farm financials. You should begin by contacting your local farm management/agribusiness Extension staff, legal and tax professionals, and others. But it must start with a plan, the farm/ranch goals, objectives, and knowing your numbers. If you do not have a way to collect the “numbers,” including production, income, costs, etc. or able to produce an easy way to review the information, you may be making decisions based on information that is incomplete at best.

With the variables presently at play today, it’s time to take a deep dive into what shocks your farm/ranch enterprise(s) can handle to determine the farm’s economic stability and sustainability.  But without knowing the farms’ “numbers” the owner/operator will not know how to appropriately plan for potential changes. 

Reach out to your local Cooperative Extension service and your legal and tax professional. Additional resources and tools can be found through your local Cooperative Extension website, and at ruraltax.org (www.ruraltax.org), Center for Farm Financial Management (https://www.cffm.umn.edu), National Council of Agricultural Employers (NCAE) (https://www.ncaeonline.org).

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Kantrovich, Adam. “Mid-Year Review and Planning.” Southern Ag Today 3(28.3). July 12, 2023. Permalink

The following information is for educational purposes. Each situation is unique, and it is strongly encouraged to utilize tax and legal professionals about this topic and others.

Income Averaging is a tax management tool that can be used by many farmers and commercial fishermen. It has been underutilized for some time but can provide benefits in many cases by reducing tax liability, depending on the facts and circumstances of the taxpayer. Income Averaging can also be used for capital gains, benefiting dairy and beef cow/calf producers who regularly cull their raised breeding livestock. 

The name of the tax management strategy is a bit misleading; it is not a true averaging of a farm’s income but allows for the utilization of potential unused lower-income tax brackets found within the three previous tax base years. Income Averaging uses the 1040F, Schedule J. Not all income can utilize this method, so the first thing that must be determined is which income is eligible to be averaged. This is known as electable income. Once the electable income is determined, you must specify the amount of income to be elected. The elected income then must be divided by three, and that value applied to each of the three base years. 

Utilizing Income Averaging, Schedule J does not affect the amount of income subject to income taxes owed. Furthermore, it does not affect Self-Employed Tax (Social Security, Medicare, etc.).

The chart below illustrates the following example. In this example, the Eli Willy Ranch, Eli is married and files a joint return. In 2019, Eli had a farm income of $72,000, in 2020 income of $65,000, in 2021 income of $70,000, and 2022 income of $110,000. Eli’s 2022 Federal Tax liability would be $15,405, not including Self-Employment Tax. But using the Income Averaging option, Eli’s Federal Tax liability would be $9,160, a savings of $6,250.

In many cases, even if the use of Income Averaging does not create tax liability savings, it may be advantageous to utilize Income Averaging to create a “hole” in the current tax year so that it can be used in future years with the hopes of higher income.

Please work with a trusted tax and or legal advisor about whether your situation can gain an advantage using Income Averaging. 

For additional farm tax publications and information, please visit ruraltax.org and IRS Publication 225, the Farmer’s Tax Guide.

Author: Dr. Adam Kantrovich

Extension Specialist, Clemson University.

akantro@clemson.edu

Most farmers right now are not thinking about taxes, let alone tax management. Many are still harvesting crops and beginning to think about the next season, but it is also time to start the office work and meet with your tax professional.  A November or early December appointment with your tax professional will give you more tax management options before year-end.

Update your accounting of transactions for the year, and arrive prepared with the necessary reports that detail the following: 

1. All revenue and sources of income.
2. All expenses with descriptions.
3. All capital asset sales and purchases (with details).
   • If an asset was traded, bring complete invoices and sales documents including information on the trade, the trade-in value, etc. 
   • Related inventory of breeding, milking, or draft livestock.
4. Bank loan payments detailing principal and interest portions.
5. An estimate of additional revenue expected, along with what might be deferred if necessary.
6. An estimate of upcoming expenses, and an idea of what expenses might be shifted (deferred or prepaid) across tax years.
7. Any health insurance premiums paid out of pocket, may be eligible for a self-employer credit/deduction.
8. All draws that have been taken.

Preparing the above reports will help your tax professional determine an approximate tax liability for this year and allow for a discussion of different tax management strategies. Remember that tax management is not about how to get out of paying taxes but should be about how to move as much income through the tax system as possible at the least expensive tax rate possible. 

Common tax management may include multiple tools or provisions. Work with your tax professional and ask about some of the following basic strategies:

1. Putting money into a retirement account with tax-preferred treatment such as a Traditional IRA or some 401k accounts.
2. Putting money into a Health Savings Account.
3. Making a commodity donation to a house of worship or other charitable organization may provide a greater tax benefit than a cash donation.
4. Utilizing prepays is a common way to lower the farm’s taxable income but check with your tax preparer about specific restrictions and requirements. 
5. Paying the accrued interest of any debt at the end of the year.
6. Utilizing any remaining Net Operating Loss (NOL) that can be carried over. It is important to remember that the NOL can only offset up to 80% of the taxable income for the farm.
7. Use depreciation strategies with caution. Section 179 and Bonus Depreciation allow a farm to rapidly depreciate an asset in a shorter period, up to a single year.  However, there are several limitations to these methods and subsequent tax consequences when the asset is sold.
8. Income Averaging is a method only available for farms and commercial fishing. It may help you avoid higher income tax brackets in one year if you have previous years with “unused” lower income tax brackets. 

Keeping up with accounting and production records throughout the year will make the end-of-year office work easier and less stressful. Having a tax professional that you can trust and is willing to work with you will help a farm meet their goals and reduce tax liability over the long term. Visit ruraltax.org for additional information and publications about taxes, including a 2022 Farm Tax Estimator tool and other information for farms, timberland owners, and landowners.

Dr. Adam J. Kantrovich,

Extension Specialist of Agribusiness and

Director of Clemson Tax School

akantro@clemson.edu

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Kantrovich, Adam. “Year-End Tax Preparation and Management“. Southern Ag Today 2(45.3). November 2, 2022. Permalink

The information found in this article should not be considered tax or legal advice, it is a brief review of options for educational purposes only. Please work with your trusted tax and legal professional to discuss various options that may be well suited to your specific situation. 

The 2021 calendar year for many farmers around the country has not failed to hold its fair share of surprises. Although we are seeing increasing input costs in many areas, we have also seen an increase in price to many crops across the agricultural spectrum, and some have continued to receive some federal program payments within the 2021 calendar and tax year. For many farmers this may create a taxable situation, especially for those that had pre-paid inputs in 2020 for their 2021 crop. There are several tax management strategies that can be used to help off-set some of the farm’s 2021 tax liability. However, you must remember a couple of points:

1. Tax management is not how to get out of paying taxes, but how to get the most amount of money through the tax system at the least expensive tax rate possible. 
2. There is no one size fits all and good tax management may require increasing your tax liability in some years.

Prepays,  IRC § 461(a); Treas. Reg. § 1.461-1(a)(1)

To purchase inputs for the following year, the farmer must utilize a cash basis accounting and tax structure (not an accrual system). The prepay amount cannot exceed 50% (IRC § 464) of other expenses with some caveats and exceptions, and prepays cannot be used solely as a means to reduce tax liability. First and foremost, it must be done for other beneficial purposes to the farm. 

Many farms utilize prepays. Prepays allow a farmer to purchase inputs for the next tax year’s production. Any expenses accrued for this may only be deducted as a cash expense for the tax year in which it was purchased if 1) there is a possibility of a supply issue and this will guarantee that you will have the input required, and/or 2) if purchasing the input in the year prior to use will save the farmer money due to a lower cost of the input(s) today vs. the year it will be used. It is required that the pre-pay has been paid by the farmer and a constructive receipt has been received. There are limits to prepays, so work with your tax professional in determining the right amount for your situation.

Income Averaging (Schedule J), IRC §1301

Income averaging uses IRS Form Schedule J Income Averaging for Farmers and Fisherman. Many farmers are on a cash accounting basis and not an accrual accounting system for accounting and tax purposes. When using the cash accounting method a farmer may see large swings from year to year in revenues and profit.  Income averaging allows farmers to spread out these peaks and valleys with some caveats. Income Averaging allows a farmer to take a portion of the taxable income from the current year, split that portion equally, and spread it across the previous three tax years to be taxed at hopefully a lower taxable rate than what it would have been in the present tax year. If there is room left in previous year’s lower tax brackets, this can be very advantageous for a farmer or commercial fisherman. 

Retirement Accounts, Health Care Accounts, and Educational Accounts

There are tax free account options that can be used to build your retirement or save for college, or Health Savings Accounts (HSA) for medical expenses. Each comes with its own advantages and disadvantages. This may include taxes owed and penalties incurred if the money is removed prematurely, and/or is not used for its intended purpose. Please speak with a trusted tax or legal professional and include a good financial planner as part of the team in these situations.

Depreciation

Most farmers are very familiar with depreciation, IRC Section 179, and Special Depreciation usually referred to as Bonus Depreciation. Many farmers utilize Sec. 179 or Bonus depreciation to make purchases of equipment, machinery, etc. and subsequently lower their taxable income. This is fine if:

1. The purchase was part of the farm’s business plan and not just a way to lower your tax bill, and
2. You are using cash to make the purchase, and do not need to take out a loan for the purchase.

In many cases the overuse of these depreciation methods has caused some farmers to get into trouble, either through creating a cash flow issue or through an increased tax liability over time. This is because there may be little “carry-over” depreciation to off-set future income since the entire value of the purchase was depreciated all in one year. Expanding debt just to save money for taxes is not a good idea, especially if it was not already built into your farm’s business plan. The farm’s cash flow may be severely impacted. Even if the farm did not need to take out a loan for the purchase, this can increase the overall tax liability by putting the farm into a higher tax bracket because of the lack of depreciation carry over to offset future income. 

Good habits have to be built and continually exercised. Now is the time to make an appointment with your tax professional to discuss some options before the end of the calendar year.  These discussions should become a part of the farm’s normal fall/winter year-end rituals. Make sure to provide your tax professional with all of the necessary information, including but not limited to year-to-date (YTD) income, expenses, any capital asset sales and purchases, any known and anticipated income and expenses between the date of the meeting and the end of the year.

Source:

Department of the Treasury, Internal Revenue Service. (2021). 2021 Instructions for Schedule J (2021): https://www.irs.gov/instructions/i1040sj.

Department of the Treasury, Internal Revenue Service. (2021). Publication 225, Farmer’s Tax Guide. https://www.irs.gov/pub/irs-pdf/p225.pdf.

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Kantrovich, Adam. “Time to Meet with Your Tax Professional.” Southern Ag Today 1(50.3). December 8, 2021. Permalink