By Larry R. Gearhardt, Director of OSU Tax School

The depreciation deduction (usually MACRS method) for assets used in a trade or business has always been very important to farmers when preparing their income tax returns. In addition to MACRS, the “fiscal cliff” legislation, passed early in 2013, allows two additional cost recovery deductions in the year a depreciable asset is placed in service. Click here to view the IRS news release on the fiscal cliff changes to depreciation.

First, Code Section 179 allows the entire cost of qualifying assets to be deducted in the year they are placed in service, subject to some dollar and income limitations. Second, Code section 168(k) allows 50% of the cost of qualifying property to be deducted as additional first year depreciation (AFYD) for property placed in service in 2012 and 2013. Since MACRS depreciation, Section 179, and AFYD can all be applied to the same asset, whichever method you choose, or a combination of all three, deserves attention as a planning tool to minimize taxes both now and in the future.

Section 179 Property
Many taxpayers are eligible to deduct (in lieu of depreciation) the cost of most tangible personal property used in the active conduct of a trade or business. The taxpayer can elect on Form 4562 to expense the cost of eligible “Section 179 property.” Under the old law, this deduction was limited to $139,000.00 for 2012 and $25,000.00 for 2013. The new legislation increased the amount that can be deducted under section 179 to $500,000.00 for 2013 and $500,000.00 retroactive to 2012. This deduction can be used for both new and used equipment.

“Eligible property” that qualifies for Section 179 includes: Machinery and equipment; Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment; Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals; Grain bins; Single purpose agricultural (livestock) or horticultural structures; and Agricultural fences and drainage tile. You cannot take the expense for drainage tile if the costs of installation were paid by a government agency. Land improvements do not qualify.

Some limitations apply to Section 179 property. First, the deduction is limited to the taxpayer’s new basis in the property. This means that if eligible property is acquired through a like-kind exchange (such as a trade-in allowance), only the “boot” payment can be expensed. Second, the expense deduction is limited to the amount of taxable income received by the taxpayer from conducting any of his active trades or businesses. This includes taxable income from Schedules C, E, or F. The unused expense deduction can be carried forward and used in following years. The Section 179 expense deduction can be used to offset income, however, the deduction cannot be used to create a “loss” from income. Third, taking the Section 179 expense deduction reduces the basis in the property the same as taking depreciation. If the property is sold before the end of its useful life, the taxpayer will be subject to “recapture” of the deduction.

A taxpayer can elect on Form 4562 not to take the Section 179 deduction, or take a portion of the deduction. If the taxpayer elects to not use Section 179, or a portion thereof, the remainder defaults to AFYD.

Accelerated First Year Depreciation (AFYD)

The new legislation continued into 2013 the additional 50% first year bonus depreciation deduction on qualified property. “Qualified property” is tangible personal property that qualifies to be depreciated under the MACRS method with a recovery period of twenty years or less. This deduction can only be used when purchasing new property and the taxpayer must be the original user of the property. Land does not qualify for depreciation, but buildings and other real property improvements can be. Property used solely for personal use does not qualify. Property that is used less than 50% in the business does not qualify.

If you do not want to take the AFYD and utilize more depreciation in later years, you can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service during the tax year. Please note that this differs from the Section 179 deduction where you can elect not to take the deduction for various items of property. To make the election, attach a statement to your return indicating the class of property for which you are making the election. If the AFYD is not claimed, the asset will be depreciated over time according to the taxpayer’s common method of depreciation.

Conclusion
The Section 179 expensing election and AFYD are powerful tools to manage income taxes. They do not increase the deduction relating to a purchase; rather, they allow a farmer to time manage purchases and deductions. Section 179 and AFYD allow for a larger deduction in the first year and smaller deductions in future years. Since Section 179 and AFYD can have both a cash flow and income tax effect, it is important for the taxpayer to understand their capabilities and make decisions in consultation with their tax professional.

More Information:
More information about each of these depreciation methods can be found on the Internal Revenue Site at http://irs.gov

Click here for the 2012 Form 4562

By Larry Gearhardt, Director of OSU Tax Schools and David Marrison, Extension Educator, ANR, Ashtabula and Trumbull Counties

Some landowners have already discovered that lease bonus and royalty dollars received for shale oil and gas lease payments over $150,000.00 per year are subject to the Ohio Commercial Activity Tax (CAT). See OSU Extension Fact Sheet at http://ohioline.osu.edu/sh-fact/pdf/SOGD_TAX2_12.pdf written by David Marrison, Extension Educator. However, some farmers may be surprised to find that they too are subject to the CAT tax because of higher gross receipts.

The Ohio CAT tax was passed in 2005 in response to a lagging economy. In exchange for the CAT tax, businesses are no longer required to pay personal property tax and individuals pay a lower Ohio income tax rate. Ohio’s income tax rate is currently approximately 20% lower than it was in 2004.

The CAT tax is an annual tax that is imposed on most businesses in Ohio and is measured by the amount of taxable gross receipts from most business activities. A business with taxable gross receipts of more than $150,000.00 per calendar year is subject to this tax, which requires the person to register as a taxpayer with the Ohio Department of Taxation. The term “gross receipts” is broadly defined to include most business types of receipts from the sale of property or the performance of services. Certain receipts are not taxable receipts and are excluded from the taxpayer’s tax base, such as dividends, capital gains, wages reported on a W-2, interest income (other than from credit sales), and gifts.

TAX RATES:
If gross receipts are less than $150,000.00, no tax is due and no registration is required. If gross receipts are between $150,000.00 and $1,000,000.00, the business is required to register with the Ohio Department of Taxation and pay a flat fee of $150.00. If gross receipts are over $1,000,000.00, the business is required to register, pay the $150.00 flat fee, plus 0.26% on the amount over $1,000,000.00.

The $150.00 annual minimum tax is due no later than May 10th of each year, payable with the annual return for calendar year taxpayers or with the first quarter return for calendar quarter taxpayers. A taxpayer with more than $1,000,000.00 in gross receipts is required to pay the tax on a quarterly basis.

CAT EXAMPLES:
If gross receipts are below $150,000.00 = no registration and no tax;
If gross receipts are between $150,000.00 and $1,000,000.00 = registration and $150.00 tax;
Let’s assume gross receipts of $1,200,000.00 = registration, $150.00 flat fee plus 0.26% on $200,000 ($520.00) equals $670.00 and requires quarterly filing.

HOW TO PAY CAT:
Electronic registration for paying the CAT is available online through the Ohio Business Gateway at http://business.ohio.gov. Additional instructions on registering and paying the tax are available on Ohio’s CAT website at http://www.tax.ohio.gov/commercial_activities.aspx