Larimer & Boulder Counties, Colorado
2008 December 17th
Jeff Tranel
• Agricultural and Business Management Economist
– Ranch raised
– Colorado State University
 Extension
 Department of Agricultural & Resource Economics
– jtranel@colostate.edu
– www.coopext.colostate.edu/tranel
• I am not a Certified Public Accountant
2
Income Taxes
• Congress alters tax code periodically
• Tax Court rules on tax issues
• Can often be
interpreted in multiple ways
• Income tax codes and
regulations are complex.
Please consult with
your tax practitioner about
application of
tax codes and regulations.
3
What Are Your Goals?
1. To make money
 Short term?
 Long term?
2. Taxes
 No taxes?
 Minimize taxes?
 Pay more taxes every year?
3. Equity (net worth)
 Maintain?
 Increase?
“A farmer will never go
broke paying taxes”
- Anonymous Farmer
4
Your Goals
ExxonMobil
After tax income =
$22.6 billion
ExxonMobil
Taxes =
$61.7 million
5
Definition of a Farm
For Profit Farming
• It is a business if there is
net income or profit in
three of last five years
• Activities consisting of
breeding, showing or
raising horses, it is a
business if there is a
profit in
two of last seven years
7
Intent to Profit
• Farming for profit
–
–
–
–
–
–
–
–
–
Operate in business like manner
Time and effort
Depend on farming for livelihood
Losses due to circumstances beyond your control
Change operation in attempt to increase profitability
Have necessary knowledge
Past success
Profits earned in some years
Expect profits in future years
8
Hobby Farming
• Definition
– Profit is not primary motive
– Farm income not primary
source of income
• Tax Implications
– Limit on deductions
– Cannot use loss to offset
income from other activities
– Report income on Form 1040
and deduct expenses on
Schedule A (Form 1040)
9
Qualified Farmer?
• 2/3 of Gross Income
– must come from farming/ranching
in current or prior year
• Gross Income = All Income
• Farm Income
= Income from Farming/Ranching
(Schedule F)
+ Gross Farm Rental Income
(Form 4835)
+ Gross Farm Income
(Schedule E, Parts II & III)
+ Gains from Sale of Breeding Animals
(Form 4797)
10
Material Participation
11
Material Participation
1. Regularly and frequently makes, or takes an important
part in making, management decisions.
2. Works 100 hours or more spread over a period of 5
weeks or more.
3. Does things that, considered in their
totality, show material and significant
involvement.
4. Does any three of the following:
a.
b.
c.
d.
Pays half
Furnishes
Advises or consults
Inspects
12
Material Participation
• Income and deductions from
farm rentals, including
government payments
received by the landowner,
are subject to self
employment (SE) tax, if:
– Sell, exchange, give away, or
use the crop shares
– Materially participate at the time
the crops are produced
13
Importance of Records
Records
• Meet the needs of:
–
–
–
–
You
Lender
Tax preparer
Other
• Are required by the IRS to be
kept for 3 years after date of filing
– 7 years in cases of suspected fraud
– Applicable years regarding capital assets
17
Farm Income
Farm Income
• Sales of livestock and other items purchased for resale
– Sales of farm products purchased for resale
– Profit or loss is the difference between the basis in the item,
usually the cost, and any payments received
– Basis may have been carried forward from a previous year
• Sales of livestock, produce, grains, and other products
raised
– Sales of all raised products
27
Farm Income
Agricultural Program Payments
– All agricultural program payments, including CRP payments
 Even if a government check was returned for cancellation or
the government collects all or part of the payments by reducing
the amount of another payment or CCC loan
– The government should send the taxpayer a Form 1099-G
indicating the total amounts received
Crop Insurance Proceeds
– Proceeds from insurance on growing crops
 Included in gross income in the year actually or constructively
received.
28
Farm Income
Crop Insurance Proceeds
– Proceeds from insurance on growing crops
 Included in year actually or constructively received
– Can be postponed until following year if:
 Use cash method of accounting
 Received insurance proceeds in same tax year as crops
damaged
 Normal business practice to sell crop in following year
29
Farm Income
Other Income
– Items that generate income during the year.
 Crop share rents
 Breeding fees
 Sales of soil
 Items not included in other sections of farm income.
30
CRP Payments
• Before
– If actively farming, active income (Sch. F)
– If not actively farming, passive income (Sch. E)
• Now
– By complying with terms of CRP contract, you are actively
farming
 CRP payments are considered “government payments” not
rental payments
• After 2007
– If receiving Social Security benefits (retirement or disability)
 CRP payments are excluded from self-employment income
31
Hedging as Risk Management
• Hedging transactions entered into
in normal course of business
• For risk management purposes
• As forward contracts, futures
contracts, options
• Commodity is produced on the
farm or directly affects the
business
• Generally an ordinary gain or loss
• Reported on Schedule F
32
Hedging as Speculation
• Hedging transactions
entered into which are not
part of the ordinary business
of farm
• Has specific record keeping
requirements
• Reported on Form 1040
33
Farm Expenses
Farm Expenses
•
Ordinary and necessary costs of operating a farm or agricultural
enterprise.
•
Capital improvements increase basis of applicable assets.
•
Depreciation reduces basis.
•
Expenditures for purchases of items for resale are not deductible
in year occurred (under cash method).
36
Car & Light Truck Expenses
• Must be able to prove deduction for travel with adequate
records or other evidence.
– Example: account book supported by things such as expense
receipts
• Not deductible for commuting miles
• Depreciation limited (if placed in service in 2007)
–
–
–
–
$3,060 in 1st year
Limits are higher for light trucks,
$4,900 in 2nd year
vans , and electric vehicles.
$2,850 in 3rd year
$1,775 in 4th and later years
• $25,000 max depreciation-for SUVs
See Publication 946.
Assumes
100% business use.
37
Car and Light Truck Expenses
• Up to 75%
– Directly in connection with farming
– In first year the vehicle is placed in service
– Cannot change to another method at later
time
• 100%
– Must have records of proof
– Must be used for business the percentage
that is claimed
38
Car and Light Truck Mileage
• Standard mileage rate
– $0.505 in 2008 (Jan 1 – Jun 30)
– $0.585 in 2008 (Jul 1 – Dec 31)
– Business miles only
– Not deductible for commuting
miles
– Cannot be used if operating 5+
cars and light trucks at the
same time
– Business rate in 2009 = $0.55
39
Prepaid Livestock Feed
• Deduct the cost of livestock feed to
be consumed in a later year if
(meet all tests)
• Deductions for prepaid livestock
feed may be limited to 50% of
other deductible farm expenses
40
Prepaid Livestock Feed
1. Payment is for the purchase of feed rather than a deposit
• Specific quantity
• Fixed price
• Not entitled to refund or repurchase
• Would be considered a deposit if:
 Absence of specific quantity terms
 Right of refund of any unapplied
payment credit
 Right to substitute other goods or products
 If there is a provision in a binding contract permitting
substitution of ingredients to vary particular feed mix to meet
livestock’s current diet requirements will not suggest a deposit
41
Prepaid Livestock Feed
2. Prepayment has a business purpose and is not merely
for tax avoidance.
• Reasonable expectation of receiving
some business benefit for prepayment
• Examples
 Fixing maximum prices
 Securing assured feed supply
 Securing preferential treatment
in anticipation of a feed shortage
42
Prepaid Livestock Feed
3. Does not materially distort income.
– Customary business practice
– Expense in relation to past purchases
– Expense in relation to income
for the year
– Time of year
43
Prepaid Livestock Feed
Summary for deduction of prepaid livestock feed:
•
Payment is for feed, not a deposit
•
Payment has business purpose,
not for tax avoidance
•
Prepayment does not
materially distort income
44
Wages for Labor
• Deduct reasonable wages
• Use fair market value of any
assets given to hired labor
• Deduct as farm expenses
the costs of boarding farm
employees
• Issue Form W-2 for all
employees
45
Contract vs. Employee Labor
• Entered as “custom hire”
• Cost must be capitalized
• “20 Factors”
• Individual contractors
receiving more than $600
must receive a Form 1099MISC
46
Hired Labor- Family Members
• Deduct reasonable wages and
other compensation paid your
child
• Deduct reasonable wages and
other compensation paid your
spouse
47
Prepaid Farm Supplies
• Amounts paid during the tax
year for feed, seed, fertilizer,
and similar farm supplies
• Must use cash method of
accounting
• Limited to 50% of other
deductible farm expenses
48
Prepaid Farm Supplies
Exceptions to the 50% Limit:
• Does not apply to farm-related
taxpayers if:
– Business operations changed due
to unusual circumstances
– Total prepaid farm supplies in
preceding 3 years is less than 50%
of total other deductible farm
expenses in those three years
49
Business Use of Home
• Can deduct expenses for
business use of home if part of
the home is used exclusively and
regularly
• Deduction limit applies
• Any depreciation taken reduces
the home’s basis
50
Business Use of Home - Telephones
• Cannot deduct cost of basic local telephone service for
the first telephone line into the home
• Can deduct:
– Business long-distance changes on the first line
– Cost of second telephone line into the home if used exclusively
for farm business
51
Depreciation
• Annual deduction recognizing
that assets wear out or become
obsolete
• Types of tangible property
• To be depreciable, property must
meet conditions
• Records of depreciation on
capital assets must be kept by
the taxpayer
52
Depreciation
• To be depreciable, property must (meet all tests):
–
–
–
–
Be owned
Used in the business or income producing activity
Have a determinable useful life
Be expected to last more than one year
• Most types of tangible property.
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–
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–
–
–
Buildings
Machinery & equipment
Vehicles
Livestock
Fences
NOT land
53
Depreciation
Recovery Period in Years
GDS
ADS
Single purpose ag structure
10
15
Single purpose horticulture building
10
15
Farm buildings
20
25
Farm machinery and equipment
7
10
Ag fences
7
10
Truck (13,000 lbs or more)
5
6
Water wells
15
20
54
Depreciation
Recovery Period in Years
GDS
ADS
Cattle (dairy and breeding)
5
7
Goats and Sheep (breeding)
5
5
Horses (age when placed in service)
Breeding & Working (12 years or less)
Breeding & Working (more than 12 years)
7
3
10
10
Hogs (breeding)
3
3
55
Depreciation – Breeding Livestock
• Raised breeding livestock:
– Not typically depreciated
– Incurred expenses deducted as ordinary farm expenses
– Have no basis when sold
 Sale price less selling costs equal capital gains
56
Depreciation Limits
• Limits
–
–
–
–
–
Passenger automobiles of < 6,000 lbs (GVW)
Entertainment and recreational property
Computers
Cellular telephones
Generally, most assets that lend themselves to personal use
57
Depreciation – Section 179
• Allows deducting all or part of
qualifying property in the year
“placed in service”
• Qualifying property
• Property must be used more than
50% for qualified business use
58
Depreciation - Section 179
• Allows deducting all or part of qualifying property in the year “placed
in service”.
• Qualifying property:
–
–
–
–
Purchased for business use
Personal property, ag fences
Single purpose ag structures
Does not include real property
• Property must be used more than 50% for qualified business use.
• Limits in 2008
– Apply to individuals
– $250,000 for married couples filing jointly (MFJ)
– Reduced as total cost of all qualifying section 179 property placed in
service within the tax year exceeds $800,000
59
Depreciation – Example 1
$125,000
- 0
Adjusted purchase price for machine
Section 179 Allowance
125,000
Depreciable basis
/ 7
Years of recovery
= 17,557
X 50%
= $8,929
Depreciation using SL method
Calculation for half-year convention
Depreciation for 1st year (year placed in service)
60
Depreciation – Example 2
$125,000
- 100,000
Adjusted purchase price for machine
Section 179 Allowance
25,000
Depreciable basis
/ 7
Years of recovery
= 3,571
Depreciation using SL method
X 50%
Calculation for half-year convention
= $1,786
Depreciation for 1st year (year placed in service)
61
Multi-Year Effects of Depreciation Decisions
2003
2004
2005
2006
2007
2008
Total
870
662
447
227
2,206
7,182
7,390
7,604
7,825
30,000
Loan Payments
Interest
Principal
Example 1: Using MACRS Depreciation
Depreciation
4,500
7,650
5,355
4,998
4,998
2,499
30,000
Tax savings
1,679
3,178
2,244
2,031
1,949
932
12,013
7,773
9,262
9,602
9,733
Revenue needed
36,370
62
Strategies for Managing Tax Liability
Tax Management Goals
• It may not be best to minimize
taxes
• Should maximize after tax
income across multiple years
• Matching depreciation
deductions to loan payments
• May not “show up” on financial statements
• Tax management decisions in one year can affect cash
flow and financial viability of a firm in future years
64
Tax Management Goals
• Match depreciation deductions
to loan payments
• Manage taxes and financial
risk over multiple years
• May want to take bigger
deductions up front to keep
out of a higher tax bracket
• Deferred taxes may not catch
up to the farmer until retirement
65
Defer Tax Payments
• Tax minimizing strategies
only defer (delay) income
tax payments
• Many farmers report crop
revenue in one year and
expenses on another
year’s tax return
• Large tax consequences
may result at a time when
financial hardship already
exists
66
Reducing Profits – Gross Income
• Postpone receipt of revenues
• Reduce revenues from livestock and crop sales
• Reduce non-livestock/crop revenues
67
Reducing Profits – Expenses
•
•
•
•
•
Prepay supplies
Prepay feed
Increase expenses
Increase depreciation
Pay higher than necessary
prices
• Use extraordinary amounts of
items
• Pay consultants
68
Increase Taxable Income
• Reasons why someone might want to increase taxable
income:
69
Increase Taxable Income
• Reasons why someone might want to increase taxable
income:
70
Increase Taxable Income
• Reasons why someone might want to increase taxable
income:
71
Increase Taxable Income
• Reasons why someone might want to increase taxable
income:
72
Taxes
Self Employment Taxes
Rate = 15.3%
– Social Security = 12.4% (max earnings = $102,000)
– Medicare = 2.9% (max earnings = unlimited)
Net Farm Income + Other SE Income
X 92.35%
= Net Earnings From SE
X 15.3%
= Self-employment Taxes
If net earnings from self-employment
is less than $400,
there is no SE Tax liability.
74
SE Taxes – 4-H/FFA
• Sales of 4-H and FFA projects
are generally not subject to SE
taxes
– Project must be primarily for
educational purposes
– Project completed by the
individual under rules and
economic restrictions of the
sponsoring 4-H or FFA
organization
75
Standard Deductions & Exemptions
2008
• Standard Deductions (under 65)
– $ 5,450 Filing Single
– $10,900 Married Filing Jointly
– $ 8,000 Head of Household
• Personal Exemptions
– $ 3,500 per dependent
– Phased out as adjusted gross income certain level
76
Tax Rate Schedule (MFJ) - 2008
Income Range
Income Tax
More Than
Less than
Amount
Plus Percent times Amount Over
---
16,050
---
10%
0
16,050
65,100
1,605
15%
16,050
65,100
131,450
8,963
25%
65,100
131,450
200,300
25,550
28%
131,450
200,300
357,700
44,828
33%
200,300
357,700
---
96,770
35%
357,700
77
Retirement Accounts
• Traditional IRAs
– Adjustments to gross
income
– Taxed when withdrawn
– Required distribution (70 ½)
– Contribution limits, generally
 $5,000 in 2008
 $6,000 (if 50+)
• Roth IRAs
– Taxed in year of investment
– No required distribution
– Contribution limits, generally
 $5,000 in 2008
 $6,000 in 2008 (if 50+)
• SIMPLE, SEP-IRA, Keogh,
Other
• Publication 590
78
Estimated Taxes
• Farmers not required to make estimated payments.
– Qualified farmer
– File tax return and pay all taxes by March 1st
• Qualified farmer can make a single estimated payment
by January 15th
– Then has until April 15th to file tax return and pay balance of
taxes owed
• Making estimated payments
– Must, if above to not apply
– May
79
More Information
• See your tax preparer
• Visit the IRS
– Telephone
– Website (www.irs.gov)
– Publications and Forms
 Publication 225 (farmers tax guide)
80