Hold up, there. Before you start spending money at year’s end to reduce taxes, realize that it might not be the best move. Some tax experts are actually advising farmers to boost their income for 2012 because tax rates are set for a hefty increase next year in addition to tax credits tumbling.
The maximum income tax rate of 35% is scheduled to increase to 39.6% in 2013. Additional tax hikes include a 0.9% Medicare surtax and a boost in the capital gains rate to help fund the health care law. There’s a chance that Congress will take action to prevent tax hikes between now and early 2013, but it’s important to have a game plan either way.
Don’t be overly eager to use up all the deductions that can be used in future years, particularly 2013, says Brad Palen, a CPA and partner with Kennedy and Coe in Salina, Kan.
This is particularly true because strong farm income is again expected next year. Pushing too much income into 2013 could hurt your bottom line if you look at 2012 and 2013 together, Palen says. Every farm tax case is different, he cautions, and what is a good strategy for one producer is not always good for another.
Deferred payments. "Flexibility is particularly important this year, not knowing whether Congress will pass anything that reduces rates for 2013," Palen says.
One key way to remain flexible is through deferred payment contracts. For example, producers can sell and deliver grain this year but receive the payment in 2013. When filing the 2012 return next year, they can decide whether to claim the income in 2012 or 2013. By then, Congress should have made up its mind on tax credits and rates. (When using deferred payment contracts, remember that if the firm goes belly-up, you’re out your money, Palen notes.)
Crop insurance payments. How do crop insurance payments received in 2012 fit into the equation? "If you are in the habit of selling at least 50% of your grain the year following when it’s produced, you can roll the crop insurance income into 2013," says Darrell Dunteman of Bonnett and Dunteman LLC Certified Public Accountants and Consultants in Bushnell, Ill. Farmers cannot roll the revenue portion forward, however, only the crop yield loss.
Income averaging. One tool Dunteman uses with farm clients who have an income boost is income averaging. This is not available for Social Security tax obligations, however.
Drought provisions. Specific tax provisions are in play for livestock producers due to the drought. If you had to sell breeding stock because of a lack of feed, you can elect to roll that gain into replacements within two years. If the drought caused a disaster declaration, the replacement period is four years, says Phil Harris, University of Wisconsin tax specialist.
Depreciation catch. This year, bonus depreciation is in play, which means producers can deduct 50% of any qualified equipment purchase made in 2012, such as farm equipment, tiling and farm buildings. The catch is that the purchases have to be placed in use by year-end, which means that building construction has to finished by Dec. 31, Dunteman notes. Next year, there is no bonus depreciation.
When it comes to Section 179 expensing, $139,000 can be deducted this year for qualifying purchases of $560,000 or less. Next year, only $25,000 can be deducted.
Section 179 provisions are popular with all businesses, so there will be pressure on Congress to pass an extension, as has been done in the past.
Should farmers who bought equipment this year use Section 179 and bonus depreciation in light of higher tax rates? "Next year could be a pretty high taxable year," Harris says. "Producers may want to save some of their deductions for 2013."
Each farm is different, so you need to discuss the possibilities with your accountant. "I generally like to use up depreciation when I can," Dunteman says. "Then I balance taxable income with prepayment of seed, chemicals and fertilizer, or deferral of income."
For some, it might make more sense to use those deductions in 2013. "Most prepayment discounts will be available until Jan. 5," Dunteman says.
Capital gains. The hike in capital gains taxes from 15% to 20% will take effect on Jan. 1, 2013. Anyone selling land, stocks, investments or breeding livestock herds might want to close the deal before year-end, says Mark Olson, CPA, of Conway, Deuth & Schmiesing, PLLP in Willmar, Minn. Machinery and livestock inventory is not included.
There will be a 3.8% surtax for single taxpayers with unearned income (including capital gains) and adjusted gross income in excess of $200,000; $250,000 for married couples. This
surtax will fund the health care bill and will go into effect even if Congress rolls back the scheduled increase in capital gains tax rates. Because of this, experts suggest that producers whose farms are incorporated pay dividends before year-end.
Is Now a Time to Gift?
If you’re nearing completion of your estate plan or considering gifting some of your property, now is probably the time to act. As the estate law stands, gifts up to $5,120,000 are tax-free. Beyond that amount, the top gift tax rate is 35%. After Jan. 1, assuming Congress makes no changes and the law reverts back to what was in place before Congress made changes in 2001, only the first $1 million of gifts are tax-free, with anything beyond that taxed at 41% to 55%.
"A lot of people are wondering if they should gift," says Mark Olson, CPA, of Conway, Deuth & Schmiesing PLLP in Willmar, Minn. While gifting makes sense for many farm families, assuming they already have an estate plan, they also have to realize this: "Once land is gifted, it’s gone."
File an Extension
Farmers might want to plan to file an extension for 2012 returns because so much tax policy is uncertain. That would give them until Oct. 15, 2013, to file returns. The extension does not defer payment, however, which means making an estimated payment on Jan. 15 and paying the balance when filing for an extension before April 15, says Brad Palen of Kennedy and Coe.