Thanksgiving dinner is planned. Christmas carols will soon tease the senses with promises of glad tidings to come. A New Year is just around the corner.
But amidst all the revelry, another, more sobering year-end event looms: year-end tax planning.
Questions abound. Should you go into 2008 with prepaid feed? Do you buy the new baler you'll need next summer before year's end? Do you defer income or not?
While every producer faces a different situation, high cattle prices, high feed prices and high overall input costs can make even the smallest operator's books read like a Wall Street ledger. And that makes thinking ahead an essential activity this time of year.
“Year-end tax planning is certainly needed for most in agriculture, due to where the markets are,” says David Eck, a CPA who operates an Amarillo, TX accounting firm that includes a clientele of ranchers, cattle feeders and farmers.
George Patrick, Purdue University agricultural economist, says that in recent years, there are many newer tax laws that benefit agricultural producers, even though there weren't many changes from 2006 to 2007. “For example, the recent changes in (federal income tax) Section 179 expensing limits have almost eliminated many farmers' need to pay any federal income tax, assuming they're making capital purchases,” says Patrick, author of the report, “Income Tax Management For Farmers.”
“However, reducing income-tax liability may not be sufficient reason to make additional investments in depreciable assets. Furthermore, eliminating one's tax liability for this year isn't necessarily good tax planning.”
Tax planning 101
Knowing what is taxable and what can lower the tax burden can be as elementary as knowing that you have to fix the fence. Others take a little more thought.
The domestic production activity deduction (DPAD) increased from 3% in 2006 to 6% in 2007. It starts with domestic production gross receipts (DPGR), the receipts from the sale of qualified production property. For cash-basis producers, that would include receipts from the sales of livestock, produce, grains, cotton and other products raised by the rancher, feeder or farmer. DPGR includes the full sales price of livestock, such as feeder cattle, and other products purchased for resale.
Qualified production activities income (QPAI) is part of the tax equation. QPAI is equal to DPGR minus the cost of goods sold, other deductions and expenses able to be directly allocated to such receipts. It also includes the share of other deductions and expenses not directly allocable to such receipts.
For farmers and ranchers, qualifying activities include cultivating soil and raising livestock, as well as storage, handling and other processing of agricultural products, excluding transportation activities in some cases.
Patrick reminds producers that government subsidies and payments for non-production are substitutes for gross receipts and qualify as DPGR. Subsidy payments that are directly linked to production, such as the loan deficiency payments (LDPs) and counter-cyclical payments, would be counted as income.
Payments under the Conservation Reserve Program (CRP) are related to past production “and are clearly a substitute for gross receipts,” Patrick says. Crop and revenue insurance payments received would also be included in DPGR.
Patrick says the DPAD is limited to the smallest of: 6% of QPAI, 6% of adjusted gross income of the individual, or 50% of the W-2 wages paid. Some producers may want to pay family members for work done to create or increase their DPAD.
“The DPAD gets somewhat complicated, especially if partnerships, LLCs or S corporations are included,” Patrick says.
Eck says the complexity of the DPAD regulations likely make it essential that producers confer with their tax accountants when their financial positions place them in the category where the provisions may be used.
Pre-pay or defer?
Eck says there can be many factors that help determine whether a cattle feeder, cow-calf or stocker operator buys feed before year's end that will go toward next year's production.
“If you had cattle go on feed this fall to come out of the feedyard in March, you can pre-buy the feed. But do you need that tax deduction for 2007 or 2008?” he asks. “If you have a big profit for this year already and you're a cash-basis taxpayer, you may need a large feed bill as a deduction. But if you need the deduction more for 2008, then you can wait and pay it in 2008.”
The wait for 2008 could be on the minds of more than one producer or feeder. The reason is the possible shift in power in the White House. That, with an extension of the Democratic-majority Congress, may have some worried about a higher tax rate or reduction of deductions in future years.
“You just need to know where you are for the year,” says Eck. “You may not be too excited about increasing an already significant roll forward of taxable income into subsequent years.”
Buying that new baler or tractor late in the year might provide even more tax advantages. The tax law's Section 179 expensing limit provision has been extended from $108,000 for 2006 to $125,000 for 2007. That means that many pieces of equipment bought for use on the ranch or farm in 2007 can be depreciated 100% the first year, up to the $125,000 limit for 2007.
Bill Clune, a First National Bank of Omaha agricultural lender, says he normally doesn't give tax advice to producers. But he sometimes points out how major capital expenditures can alter a producer or feeder's production budget and income-tax position.
“Most of our customers work with their own accountants to determine the impact of an expenditure on their tax liability,” Clune says. “We work with customers who are concerned about how capital expenditures will impact their overall loan program.
“We can help them deal with their capital expenditures. Because of today's banking environment, many producers or feeders need some guidance with regard to not only the dollar amount of capital expenditures, but how they structure the financing of those amounts so the operation can stay within the boundaries of their lending agreements and their historical earning will cash-flow those type of expenditures.”
Also, if customers need to look at leasing rather than buying equipment, lenders like Clune can help examine cash flow, as well as look at tax issues that may be different with a lease program. “There can be a whole other set of numbers in the area of expenditures,” he says.
Patrick says the Section 179 provisions are the only major change from 2006 to 2007. Learn more at: www.agecon.purdue.edu/extension/pubs/taxplanning.asp.
There are various other sections of the tax laws that can apply to producers in different parts of the country. For example, Patrick reminds cattlemen who operate in drought-stricken areas that previous provisions requiring replacement of cattle sold due to drought have been revised.
“There had been a requirement for cattle sold as a result of drought to be replaced within two years to avoid having to report the gain,” he says. “But that requirement has been extended to ‘indefinitely’ if the drought has persisted in the producer's area.”
In other words, producers would not face a tax liability for the forced sale of cattle due to drought as long as they replace them once climate and growing conditions improve.
In addition, conservation-easement programs enable you to donate land for conservation purposes and receive major tax benefits. However, be aware that the provisions expire after 2007. Talk with your tax or estate-planning consultant, or log on to www.lta.org/farmersandranchers.
For donating conservation easements, producers and others may deduct the value of the easement, up to 50% (up from 30%) of their adjusted gross income (AGI) in any year. If the majority of their income came from farming, ranching or forestry, they may deduct the value of the easement up to 100% AGI and continue to carry over unused portions of deductions for as long as 15 years (up from 5 years) after the initial year in which the deduction was claimed.
Eck points out another valuable deduction producers often overlook: retirement-plan contributions. These may be as simple as traditional IRAs, Savings Incentive Match Plan (SIMPLE) IRAs or Self Employed Plan (SEP) IRAs, or as complicated as defined-benefit plans. The deductions, too, can vary from slight to in excess of $50,000, depending on the producer's circumstances.
“Good tax planning should seek to maximize after-tax wealth over time, not minimize taxes paid in a particular year,” Patrick concludes. “With the changes that are occurring, producers may need to update their tax-planning techniques.”