There is a running joke in farm country that a producer with a new pickup on Dec. 31 is avoiding a tax bill. Indeed, farmers have long used the Section 179 expense deduction to expense equipment purchased during the tax year and then depreciate the remaining cost on that equipment.
This tax tool can be extremely beneficial—if the farmer can truly afford the equipment or asset purchased, says Rob Holcomb, University of Minnesota Extension educator. "I’d argue that lots of machinery has been purchased over the years that probably didn’t need to be purchased and was bought solely for tax management," he says. "This is not smart business management."
Farmers who use the Section 179 expense deduction and finance a new equipment purchase will be making payments on it for several years but getting no depreciation expense on an annual basis because they took it all up front, Holcomb explains. "This can really get farmers upside down if they are not careful," he says.
However, if a farmer has properly analyzed his business, the capital replacement margins are adequate and the farm operator is not financing the entire purchase, the use of Section 179 makes more sense, Holcomb says.
For 2010, the Section 179 deduction is limited to $250,000 and is phased out if the farmer purchases more than $800,000 of equipment, says Paul Neiffer, a CPA with Hansen NvO who specializes in farm tax issues. The expense deduction cannot reduce the earned taxable income of the farmer below zero (including wages earned by the farmer and his spouse).
Whatever amount of the equipment or machinery purchase is not reduced by the Section 179 deduction is depreciated using normal tax rules, Neiffer explains.
Section 179 Advantages. By using this tool correctly, Neiffer believes, there are many favorable tax planning initiatives for farmers.
One is reducing net taxable income and moving from one tax bracket to another. For example, assume a farmer has net taxable income of $300,000 and purchased farm equipment with a cost of more than $250,000. The farmer can elect to take the Section 179 deduction on this equipment and move from the 35% income tax bracket to the 15% bracket.
Optimum planning usually calls for a profitable farmer to take advantage of the 15% tax bracket each year. "It will probably never be lower than this in the future," Neiffer adds.
Another advantage of Section 179 is generating a full earned income tax credit. For those years where married farmers with qualifying children have large equipment purchases, they may be able to reduce their taxable income enough to maximize the earned income tax credit. This is a payment from the IRS for earned income of between about $13,000 and $16,000, and the credit is almost $5,700 for families having three qualifying children, Neiffer says.
Top Producer, October 2010