October/November is not only harvest season, but a great time to estimate the years income tax liability. With nearly two months remaining in 2005, adjustments for income and expenses may still be made with significant effects on tax liability. After January first, there is little room to maneuver these adjustments, other than choosing depreciation options or a contribution to an IRA. Some expenses, however, may not be pre-paid. Rent payments, for example, made in advance may only be deducted in the year to which they apply. The following is extracted from a Purdue tax management publication by George F.Patrick.
“Most farmers use the cash method of accounting. Farm expenditures are normally deductible when paid. Receipts are generally reported as income in the year in which they are received. As a result, farmers have the opportunity to review their year-to-date receipts and expenses, and make potentially money-saving adjustments for taxes. But that window of opportunity closes for all practical purposes with the end of a farmers tax year. So now is the time to review and adjust if necessary.
One’s tax management goal should be maximizing after-tax income or wealth over time, not minimizing taxes in any one year. Some people get so concerned about saving a few dollars in taxes this year that they miss the big picture. Because of the new Section 179 expensing and additional first-year depreciation deductions, many farmers may simply assume that they will not have a tax problem, instead of viewing each year as a tax-planning opportunity.
Keeping taxable income relatively stable year-to-year has been a key to effective income tax management in the past, because of the progressive nature of income tax rates. Recent tax law changes have “flattened” tax rates, reducing the progressiveness of income tax. Wide swings in taxable income are likely to result in higher taxes, although farm income averaging may help. The amount of income that is “tax free” because of personal exemptions and the standard deduction has increased due to law changes and inflation. One should plan to report at least this “tax-free” amount of income each year. Self-employment taxes are larger than income taxes for many farmers and may be more difficult to manage because of limited exemptions and deductions.
As a minimum, individuals should tally their receipts and expenditures before the end of the tax year. This allows year-end tax planning. Depending on the income situation, additional sales may be made before December 31, 2005 or delayed into 2006. A part of the 2006 direct payments from the government for corn, soybeans, and wheat can be collected in 2005 or after January 1, 2006. Section 179 and additional first-year depreciation elections can have a major impact on taxable income, and these decisions can be made after the close of the tax year. However, the depreciable assets must have been purchased before the end of the year. December purchases of feed, fertilizers, and chemicals to be used in 2006 can also affect the taxable income. Although delivery of inputs purchased before December 31 is not required for a tax deduction, a purchase rather than just a deposit must be made in order to claim a deduction for prepaid expenses. This means that the invoice should list specific products, and quantities and the arrangement should not pay interest to the purchaser.
Deferral of income and income taxes can still be an effective tax management strategy. If income taxes are deferred, even for a year, this is an interest-free loan from the government. Although the estimated tax payments required to avoid penalties have been increased to 90 percent of the tax liability, farmers continue to have an exception. If two-thirds or more of gross income is from farming, farmers can pay the tax due by March 1 and avoid estimated tax penalties. Although farmers must pay by March 1, the due date of their return for many other purposes, such as retirement plan contributions, is April 15.
Tax implications of major decisions should still be considered before the transactions are finalized. Installment sale contracts often have tax benefits because the taxable gain on the sale is spread pro rata over the tax periods in which the contact payments are received, with certain exceptions. Tax-free or like-kind exchanges, such as the trade-in of machinery and equipment, may reduce taxes, but farmers need to consider both income and self-employment tax impacts. Because of the complexity of the tax laws and regulations, competent professional tax advice is generally a very worthwhile investment.”