Tax Management

Now is the Time for Tax Planning

This time of year is a good time to do an income tax estimate. Cash basis tax payers have the opportunity to adjust income and expenses before December 31 st . For example, if you are experiencing a low income year, consider selling enough farm products to take advantage of the standard deduction (Single is $5350 and Married is $10,700) and personal exemptions ($3400) which represent a “zero tax bracket” opportunity. Also, if livestock (other than poultry) held for any length of time for draft, breeding, or dairy purposes are sold because of weather-related conditions, the gain realized on the sale does not have to be recognized if the proceeds are used to purchase replacement livestock within 2 years from the end of the tax year in which the sale takes place. The 2-year replacement period is extended to 4 years if the weather condition that caused the excess sales also caused an area to be eligible for assistance by the federal government.

For farmers receiving crop insurance or disaster payments, there is an exception to the general rule that payments must be reported in the year they are received. It allows a cash-basis farmer to postpone reporting a crop loss payment by 1 year. (It does not allow the taxpayer to accelerate reporting the payment if the payment is received the year after a loss.) To qualify for the exception, a taxpayer must use the cash method of accounting and must be able to show that, under the taxpayer’s normal business practice, the income from the crop would have been reported in a year following the year of the receipt of the payment.

Farmers with high income have a number of options to save tax dollars. If they have children (that work on the farm) wages paid to them is a farm expense and is not subject to social security if the child is less than age18. The single standard deduction is $5350, therefore the child will pay no federal income tax up to that amount. Wages above this amount would be subject to a lower tax bracket than the parent as well.

If you use the cash method of accounting to report your income and expenses, your deduction for prepaid farm supplies in the year you pay for them may be limited to 50% of your other deductible farm expenses the year (all Schedule F deductions except prepaid farm supplies). For livestock producers, you cannot deduct in the year paid the cost of feed your livestock will consume in a later year unless you meet all the following tests: 1.The payment is for the purchase of feed rather than a deposit. 2. The prepayment has a business purpose and is not merely for tax avoidance. 3. Deducting the prepayment does not result in a material distortion of your income. Cash rent for next year can not be a prepaid expense; advanced payments must be deducted in the year that they apply.

The Small Business and Work Opportunity Tax Act of 2007 (SBWOTA), enacted May 25, 2007, increased the annual I.R.C. § 179 expense limitation and phase-out amounts for tax years that begin in 2007, 2008, 2009, or 2010. The increased maximum annual expensing amount for the I.R.C. § 179 deduction is $125,000 for 2007 (subject to the phase-out threshold of $500,000).

Income averaging, using Schedule J, may also be an option for farmers with extra high income in 2007. It allows an elected portion of income for this tax year to be equally spread back over the previous three tax years. Therefore, allowing unused, lower tax brackets from previous years to be applied to 2007 income.

Here are useful tables for your income tax planning:

MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES

If Taxable Income Is:

Not over $15,650, the tax is 10% of the taxable income

Over $15,650 but not over $63,700, the tax is $1,565 plus 15% of the excess over $15,650

Over $63,700 but not over $128,500, the tax is $8,772.50 plus 25% of the excess over $63,700

Over $128,500 but not over $195,850, the tax is $24,972.50 plus 28% of the excess over $128,500

Over $195,850 but not over $349,700, the tax is $43,830.50 plus 33% of the excess over $195,850

Over $349,700, the tax is $94,601 plus 35% of the excess over $349,700

SINGLE INDIVIDUALS (OTHER THAN SURVIVING SPOUSES AND HEADS OF HOUSEHOLDS)

If Taxable Income Is:

Not over $7,825, the tax is 10% of the taxable income

Over $7,825 but not over $31,850, the tax is $782.50 plus 15% of the excess over $7,825

Over $31,850 but not over $77,100, the tax is $4,386.25 plus 25% of the excess over $31,850

Over $77,100 but not over $160,850, the tax is $15,698.75 plus 28% of the excess over $77,100

Over $160,850 but not over $349,700, the tax is $39,148.75 plus 33% of the excess over $160,850

Over $349,700, the tax is $101,469.25 plus 35% of the excess over $349,700

CAPITAL GAINS RATES (NONCORPORATE TAXPAYERS)

Category of Gain Tax Rate

Gain on collectibles, the tax rate is 28%

Unrecaptured Depreciation I.R.C. § 1250 gain, the tax rate is 25%

Net long-term capital gain, the tax rate is 15%

Reduced long-term capital gain rate if ordinary tax rate is 10% or 15%, the tax rate is 5%

Tax Advantaged Retirement Planning

In general, people do not put enough money aside for retirement.  Furthermore, with life expectancies increasing, the nest egg required to fund a retirement has also continued to grow.  Medical costs are increasing twice the rate of inflation and Social Security will not be enough for a comfortable retirement.  What should a person do?  At least fully fund Individual Retirement Accounts such as (IRAs), 401(k) or 403(b) plans, and if self-employed a SIMPLE IRA or Simplified Employee Pension (SEP).  Often, money put into these plans are tax deferred or deductible and, at times Uncle Sam even pays for some of it by an income tax credit.

For example, the Pension Protection Act of 2006 extended the IRC Secton 25b saver’s credit permanently.  The non-refundable credit is calculated as a percentage of the qualified contributions made to a retirement account. The credit ceiling for any individual is $1,000. The percentage is based on AGI and filing status, and the credit phases out as income increases. Contributions qualifying for the credit include those made to traditional IRAs, or Roth IRAs, plus elective deferrals to I.R.C. § 401(k) plans, I.R.C. § 403(b) annuities, I.R.C. § 457 governmental plans, SIMPLE IRAs, SARSEPs, and voluntary after-tax contributions to a qualified plan such as the federal Thrift Saving Plan.

Form 8880, Credit for Qualified Retirement Savings Contributions, is used to calculate the amount of the credit, which can be used to offset both income tax and alternative minimum tax. The income limits for each credit percentage increased for 2007 returns.

Saver’s Credit
Credit Rate    MFJ Income          Head of Household     Single/ MFS Income
 50%         Up to $31,000            Up to $23,250               Up to $15,500
20%         $31,001–$34,000       $23,251–$25,500           $15,501–$17,000
10%         $34,001–$52,000       $25,501–$39,000           $17,001–$26,000

As an example, if a person that is married and files jointly with an adjusted gross income of $32,000, 20% of a $4000 IRA contribution would be eligible for a $800 tax credit. Even if a Saver’s Tax Credit is not available because of higher adjusted gross income levels, the tax deferred aspect of retirement plan savings is still a valuable consideration.

How much can a person contribute to the various plans:  See these charts:

RETIREMENT PLAN CONTRIBUTION LIMITS
Year                      IRAs              SIMPLE       401(k), 403(b) & SEP
 2001                     $2,000             $6,500                 $10,500
2002                     $3,000             $7,000                 $11,000
2003                     $3,000             $8,000                 $12,000
2004                     $3,000             $9,000                 $13,000
2005                     $4,000             $10,000                $14,000
2006                     $4,000             $10,000                $15,000
2007                     $4,000             $10,500                $15,500
2008                     $5,000

AGE 50 CATCH-UP CONTRIBUTION LIMIT*
Tax Year    IRAs    SIMPLE Plans   All OtherPlans
 2002      $ 500        $ 500                $1,000
2003        500         1,000                 2,000
2004        500         1,500                 3,000
2005        500         2,000                 4,000
2006      1,000        2,500                  5,000
2007      1,000        2,500                  5,000
2008      1,000         TBA                    TBA
*The limit is adjusted annually for inflation in $500 increments

Some farm families are experiencing high incomes and should consider this as an opportunity to save for retirement.  In the long run, it may pay a lot better than buying depreciable assets as a strategy to save tax dollars.

Become More Energy Efficient and Earn Tax Credits

In 2006, and now in 2007, a person can earn up to a $500 Income Tax Credit for the cost of energy efficient home improvements.  The 10% tax credit is for items in your main home: exterior windows, insulation systems, exterior doors and metal roofs that meet the Energy Star requirements.  The law also provides for a $50 credit for such things as an eligible main air-circulating fan and  a $150 credit for a qualified natural gas, propane or oil furnace or a hot water heater.   The maximum credit per tax year is $500, but no more than $200 can come from window expense.

There is also a credit for adding qualified soar panels, solar water heating, or a fuel-cell power plant for the main home.  Taxpayers are allowed a credit up to 30% to a maximum of $2000 for these qualified investments.  Use Form 5695 for the Residential Energy Efficient Property Credit.  Remember, these items must be placed in service before January 1, 2008.

IRS has a list available of Alternative Motor Vehicles , placed in service after 2005, that may qualify for a tax credit..  Also, there is a newer credit for a Qualified Hybrid Motor Vehicle.  The credit varies with each one as fuel efficiency is compared with the 2002 models. The full credit amount is $2,600 for the highest qualified vehicles.  For more information, check out the web site:  www.IRS.gov .  The Hybrid Vehicle credit is good through 2010 for passenger cars and light trucks, and 2009 for other vehicles.

Capital Gains and Corporate Dividend Taxation

Capital gain and dividend tax rates were lowered in the 2001 Tax Act and had been extended two more years through December 31, 2010.   The rates are 0%, 5%, and 15%, but in 2008 would have gone back up to 20%.  The capital gain rates are now are at a maximum of 15%, however if the taxpayer is in an ordinary income tax bracket of 10 or 15 %, the rates on capital gain is only 5% in 2007 and zero for 2008-2010.   In essence, this extension of favorable rates matches the remaining tax legislation time-lines and changes from the 2001 Act, that for the most part “sunsets” in 2011, and reverts back to previous tax law.

Dividends are taxed at ordinary income tax rates, however qualified dividend income was included for the same, favorable capital gain rates, with this legislation, until 31 December 2010.  In other words, a maximum of 15% on qualified dividends, for some taxpayers only 5% in 2007 and zero in years 2008-2010.  This could be important for Corporations, accumulating profits and not paying out enough dividends.  There is a penalty tax, equal to 15% (Accumulated Earnings Tax), on Corporations that accumulates earnings and profits to avoid income tax to its shareholders.  This tax is in addition to the regular corporate tax.  Now, through 2010 would be a good time to consider paying out higher dividend payments to corporate shareholders while this tax is so much lower.

Fuel Tax Credit or Refund

Farmers may be eligible to claim a credit on the federal income tax return for the federal excise tax on certain fuels. Also may be eligible to claim a quarterly refund of the fuel taxes during the year, instead of waiting to claim a credit on the annual income tax return.

Whether a person can claim a credit or refund depends on whether the fuel was taxed and the purpose (nontaxable use) for which the fuel was used. The nontaxable uses of fuel for which a farmer may claim a credit or refund are generally the following.

  • Use on a farm for farming purposes.
  • Off-highway business use.
  • Uses other than as a fuel in a propulsion engine, such as home use.
See Publication 510 for information about credits and refunds for fuels used for nontaxable uses.   Form 4136, Credit for Federal Tax Paid on Fuels, is to be used to claim the credit, which is $.183 for gasoline and $.243 for undyed diesel fuel or undyed kerosene.  There is no refund or credit for dyed diesel fuel.  The Leaking Underground Storage Tank (LUST) tax, that is included on sales of dyed diesel fuel and dyed kerosene, is $.001 and cannot be refunded.

Free Money at Tax Time

Early returns of Federal Income Taxes have indicated that many tax payers are not completing the line on the various income tax forms to receive the Federal Excise Tax Credit or Refund. This is like “free money” since a credit reduces taxes dollar for dollar. The refund is for the 3% federal excise tax on long-distance telephone service billed after February 28, 2003. Individuals may either use a safe harbor method, without documentation, or claim the actual tax paid as substantiated by telephone bills and proof of payment and filed on Form 8913. Business entities must use the Form 8913 to claim the actual tax paid. Most individuals will use the safe harbor or standard amounts on their 2006 federal income tax return, based upon the number of exemptions claimed in 2006. These are: $30 for one exemption, $40 for two exemptions, $50 for three exemptions and $60 for four or more exemptions. If a person is not required to file an income tax return, a new form 1040EZ-T will be used to claim the refund of the telephone excise tax.

It is my understanding that the Long Distance Telephone Excise Tax came about in 1898 to help fund the Spanish American War. It is nice to have that bill finally paid!

Gift Taxes and the Annual Exclusion

Federal gift tax applies to lifetime direct or indirect transfers of real or personal property. Indirect transfers include gifts of property for less than a full and adequate consideration in money or money’s worth. These include bargain sales or exchanges. The lifetime exemption amount for gift tax purposes remains at $1,000,000 through 2010. The IRS Tax Form 709 is used to record annual gifts above the annual exclusion amounts.

In 2006, the annual exclusion amount is $12,000 for a person to gift to each donee. Therefore, a Form 709 is not required for gifts totalling less than $12,000 per person, per year. Remember too, that a husband and wife may double this exclusion amount given to an individual ($24,000 per year). Beginning in 1999, the exclusion amount increased annually based on a cost-of-living adjustment. Any adjustment that is not a multiple of $1,000 is rounded to the next lower multiple of $1,000. In years 1977-1981 the exclusion amount was $3,000, in years 1982-2001 the exclusion amount was $10,000, in 2002-05 it was $11,000 and in 2006 raised to $12,000. Generally, gifts made to a souse is not included on a gift tax return, therefore there may be unlimited transfers between spouses. Other transfers not subject to gift taxes include: payment of tuition directly to a qualifying education organization (like The Ohio State University), payment of certain medical expenses paid directly to a medical provider, and transfers to political organizations for use by the organization. See your income tax professional for additional details.

IRS Announces Federal Excise Tax Refund

You may be eligible for a one-time tax refund! This one-time refund of previously collected federal telephone excise taxes may be requested on your 2006 federal income tax return. Anyone who paid long-distance excise taxes on landline, cell phone, Voice over Internet Protocol (VoIP), or bundled service that was billed for the period after Feb 28, 2003 and before Aug 1, 2006
is eligible for this refund. (Bundled service is local and long-distance service provided under a plan that does not separately list the charge for local service.)

You can request a refund of the actual federal excise tax you paid based upon your telephone bills for this period. Or you can request the standard refund amount ranging from $30-$60 based upon the number of exemptions you claim on your individual income tax return.

Choosing the standard amount is optional. Using this option is the easiest way to get your refund and avoid gathering 41 months of old phone records. By choosing the standard amount you will only need to fill out one line on your tax return. Thestandard amount is based on actual telephone usage data and reflects the long-distance phone tax paid by similarly sized families or households.

Choosing to request the actual amount paid may be more beneficial for some taxpayers. To request a refund based upon the actual amount you paid , you must determine the amounts paid based on your phone bills. Figure the refund on Form 8913 and attach this form to your 2006 income tax return.

If you are not normally required to file a tax return, there is a new form (Form 1040EZ-T) that you can use to request this refund. Form 1040EZ-T can be mailed to the IRS or it can be prepared and filed electronically at no cost by using Free File at IRS.gov.

Businesses and tax-exempt organizations are also eligible for the telephone excise tax refund. These organizations must use Form 8913, Credit for Federal Telephone Excise Tax Paid. Businesses and tax-exempt organizations may report the actual amount of refundable phone taxes they paid for the 41-month billing period from March 2003 through July 2006. Or they may use a formula established to estimate the refund. Businesses should attach Form 8913 to their regular 2006 income tax returns. Tax-exempt organizations must attach it to Form 990-T.

Conservation Security Payments (CSP) and Taxes

The CSP program is a voluntary program that provides financial and technical assistance to promote soil and water conservation. Selected watersheds are protected by paying qualified producers stewardship payments for achieving specified levels of compliance within the standards for soil and water conservation. CSP also may provide cost share payments to producers and landowners for various practices.

County Farm Service Agency offices had distributed copies of the USDA notice to recipients of CSP payments indicating that some of the CSP payments may be excluded from income, under Internal Revenue Code (IRC) Section 126. Some farmers have misinterpreted the notice, thinking that all CSP payments are excluded from income. Unfortunately, this is not the case. The following article will explain the rules for taxation of CSP payments.

Stewardship payments are made to qualifying farmers at Tier I, II and III levels. Larger payments are received for meeting higher Tier levels of compliance with resource management systems. These payments are ordinary income (lines 6a and 6b of Schedule F) and are subject to self-employment earnings. Likewise, any incentive payments are also considered ordinary income. For share-rent landowners, filing Form 4835, lines 3a and 3b are used to report CSP payments, and are subject to ordinary income taxes, but would not be subject to self-employment (SE) tax. However, IRS may argue that share-rent landlords may also be required to use Schedule F to report the CSP stewardship payments so that SE tax may be collected. For example, IRS Notice 2006-108, recently released, addresses the application of the Self-Employment Contributions Act to Conservation Reserve Program (CRP) payments. In this, CRP payments, no matter the situation, are subject to SE tax.

IRC Section 126 excludes cost-share payments from income only if they are for a capital expenditure and meet other requirements. Clearly, stewardship payments are not for capital expenditures thus are not eligible for exclusion under IRC Section 126.

If cost sharing payments are for non-depreciable soil and water conservation improvements, these may be deducted under IRC Section 175. This section allows for deduction of such improvements as for the treatment or movement of earth, construction of drainage ditches or earthen dams, eradication of brush or the planting of windbreaks. The deduction is limited to 25% of gross farm income (line 14 of schedule F), with the excess carried forward to future tax years. Expenses for improvements that can be depreciated cannot be claimed under IRC Section 175. A cash-rent landlord can not use this deduction.

Under IRC Section 126, cost-share payments for depreciable improvements made to farmers and landowners may be eligible for exclusion from income. This exclusion may be useful if the allowable depreciation for the capital improvement is less than the cost-share payment received, such as for a manure storage structure. For the IRC Section 126 exclusion, three conditions must be met: 1) The payment must be for a capital expenditure, 2) The capital expenditure must not substantially increase the annual income for the affected property, and 3) The payment must have been certified by the Secretary of Agriculture for the conservation purpose.

Under Section 126, a mathematical calculation must be made to determine the taxable portion, if any. Begin by determining the value of the Section 126 improvement. In other words, what would a willing buyer pay a willing seller for the improvement. Treasury Regulation 16A126-1 gives an example of $21,000 as a fair market value for an improvement that cost $700,000. The next step is to determine the portion of the cost-share that is excludable from income. To do this, it is the greater present value analysis of either 10% of the average annual income from the affected property for the 3 years immediately prior to the improvement or $2.50 per affected acre. Subtract this figure and the taxpayers contributing cost of the improvement from the value of the improvement to determine the taxable portion. On the Agricultural Program Payments line of Schedule F, 6a is where the entire 1099G amount is to be reported. On line 6b, only the taxable amount is written. As one can see, it may be advisable to seek a qualified income tax practitioner to assist with wading through such calculations. The IRS web site is also a useful resource: www.irs.gov .

2006 Federal Income Tax Notes

Business Travel Mileage Rates
Rather than use actual costs of operating a vehicle, a business may use the standard mileage rate on up to four vehicles.  The 2006 business mileage rate is $.445, and in 2007 it will be $.485 per mile of business use.  The depreciation component of this rate was 16 cents for 2004 and 2003.  It is 17 cents per mile for 2005 and 2006.  The depreciation component is used to reduce the basis of the vehicle for calculating gain or loss upon disposition.

Social Security
The maximum earnings subject to Social Security for 2007 will be $97,500, up $3,300 from $94,200 for 2006.  The rates for Old Age, Survivors and Disability Insurance OASDI has not changed since 1990.  It remains at 6.2% for OASDI and 1.45% for Medicare (Hospital Insurance), paid by employers and matched by employees.  Self-employed persons pay both parts themselves or 12.4% for OASDI and 2.9% for Medicare (15.3% SE Tax). The cost of one quarter of coverage goes from $970 to $1,000 in 2007.  For those under full retirement age and drawing benefits have withheld $1 of benefits for every $2 above earned income of $12,480 in 2006 and $12,960 in 2007. The cost-of-living or COLA for 2007 is 3.3%.  Considering the COLA, in 2007 the maximum Social Security retirement benefit for someone at full retirement age will be $2,116.  It is estimated that the 2007 average Social Security retirement benefit will be $1,044 for a retired individual currently drawing benefits.

Education Credits in 2006
The Hope Scholarship Credit is $1,650 per eligible student. The Lifetime Learning Credit is $2,000 per return.  The Student Loan Interest Deduction per return is $2,500.

Limits for Retirement Plan Contributions
The 2006 limits are:  IRA’s $4,000, SIMPLE $10,000, SEP, 403b or 401k $15,000,and in a Defined Benefit Plan $44,000.

Standard Deduction and Exemption in 2006
The standard deduction is $5,150 for single and $10,300 for joint returns.    For a taxpayer claimed as a dependent, the deduction is $850 or earned income plus $300.  The personal and dependent exemption is $3,300.

Capital Gain and Dividend Rates
The capital gain rate on collectibles is 28%, for long-term capital gains or dividends the maximum rate is 15%.  The long-term capital gain rate is reduced to 5% if the ordinary tax rate is 10 or 15%.