Think of tax planning as a risk management tool
Tax planning is traditionally done to limit tax liability. With uncertainty in Congress, tax rates might be higher in 2014 than 2013. If so, you might not want to defer as much income to 2014.
"When tax planning, start with year-to-date income and expenses and estimate them for the remainder of the year," says Ron Haugen, North Dakota State University Extension Service farm economist. "Do not forget any income that was deferred to 2013 from a previous year."
Depreciation also needs to be estimated, he says. "Try to spread out income and expenses so you don’t have abnormally high or low income or expenses in any one year," he says, noting to be careful deferring income so that you don’t accidentally push yourself into a higher tax bracket.
When planning 2013 tax returns, note Section 179 expense deductions, which allows you to deduct up to $500,000 per item with a cap of $2 million for capital expenditures. It’s also important to consider bonus depreciation, which allows 50% bonus depreciation on capital expenditures, and regular depreciation.
"These provisions expire at the end of this year, and we aren’t sure what will happen next year," says Larry Gearhardt, director of the Ohio State University Extension’s Income Tax School. "Farmers are going to have to sit down and think long and hard about how they can reduce their taxes this year and in the following years. If the farm economy remains strong, farmers might not have a way to offset that income."
When deciding how to file your taxes, think about your age, if you plan to expand, income earned this year, if you have a new generation coming in and the area of agriculture you are in, Gearhardt says.
"Farmers should sit down with their tax advisers to make the best decisions for their situation," he says. "Think of taxes as a risk management tool, and plan ahead rather than at the end of the year when it is too late. Preplanning is key."
Avoid Fluctuations in Taxable Income
The basic tax management strategy is to avoid wide fluctuations in taxable income. Relatively uniform income from year to year results in the lowest income tax and largest farmland preservation credits throughout a period of time. Even in a low income tax year, you should try to have enough income to use your personal exemptions and the standard deduction, says Warren Schauer, Michigan State University Extension farm business management specialist. "If you don’t use them, you lose them."
It all starts with records. A good set of financial records helps to ensure that all expenses are taken. "A good record-keeping system is essential for end-of-year tax planning, as well as working with your lender," he says.
Once your records are in order, you can do a tax estimate. Add up all your receipts and subtract the expenses, including depreciation. Add in all your gains and non-farm income, and subtract out your deductions for IRAs, medical insurance and half of your Social Security tax. Then take out the standard deduction and exemptions to get your taxable income, from which you figure your tax. For help and additional resources, visit MSU Extension’s TelFarm website at telfarm.canr.msu.edu.