Aug 22, 2014
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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

One-Third of Americans Lack Retirement Savings

Aug 22, 2014

I came across this article recently and it highlighted a retirement savings issue many people face, especially those that are self-employed.

“Many U.S. households are not adequately prepared for retirement, according to a new report from the Federal Reserve that found 31 percent of non-retired respondents indicating they have no retirement savings or pension, including 19 percent of those ages 55 to 64.”

Further, the most commonly reported form of retirement savings is a defined contribution plan, such as a 401(k) or 403(b) plan, which 44 percent of people possess. However, these plans typically are provided by an employer, which is obviously not available if you are self-employed. Here is a quick refresher on some of the more common types of retirements plans for self-employed individuals:

  • Solo 401(k)

o Maximum amount you can put in: 20 percent of net self-employment income plus $17,500, up to $52,000 in 2014; if you’re 50 or older, you can put in up to $5,500 more. This is best for those with no employees and large amounts of self-employed income as the contribution maximums are so high. There is also a Roth option for solo 401(k) plans; If you opt for the Roth version, you put in after-tax dollars and your money grows tax-free - which means it is not taxed upon withdrawal, but you don’t get the upfront tax deduction.

  • SEP IRA (Simplified Employee Pension)

o Maximum amount you can put in: 25 % of self-employment compensation, up to $52,000 for 2014. Again, based on the high levels of allowable contributions this is for those with high levels of self employment income. These tend to be more flexible and simplified plans, but if you have employees you will have to also contribute money for them, however, contributions are discretionary.

  • SIMPLE IRA (Savings Incentive Match Plan for Employees of Small Employers)

o Maximum amount you can put in: $12,000; up to $14,500 if you’re 50 or older. This is best for self-employed people with under 100 employees, although you can also have a SIMPLE IRA if you don’t have employees. If you do have employees, you generally must match up to 3% of their compensation.

These are some of the more common plans available and used, but there are other options available as well. I’d suggest discussing with your CPA and/or investment advisor to decide on the best plan for your situation.

More than 100 but Less than 500

Aug 20, 2014

When a farmer or taxpayer owns an S corporation that incurs a loss, the farmer must show that they have materially participated in the companies operations in order to deduct the loss. The slam dunk test is that the owner works for more than 500 hours. If the owner works for less than 100 hours, then it is very difficult to meet any material participation test. If the owner works more than 100 hours but less than 500 hours, then they are in the dreaded "GRAY" zone.

In an US Tax Court case decided today (Charles and Betty Wade), the Tax Court agreed with the taxpayer that he materially participated in the company's operations even though he did not work 500 hours. The company had been very successful in the plastics industry and dad semi-retired to Florida and turned day-to-day operations over to his son. Although semi-retired, he continued to spend at least 100 hours on company business.

With the great recession of 2007-2008, the company started to lose money and he became more and more involved and actually spent substantial time on R & D and developed a new product for the company in 2008 plus made several trips to the company to reassure the workers they still had a job.

During 2008, the company lost over $3 million and the taxpayer carried the loss back and got a refund of about a $1 million. The IRS audited the amended returns and denied the loss claiming the taxpayer was not materially active in the company. The taxpayers claimed that they met one of two tests (1) he worked at least 500 hours in the business; or (2) he participated in the companies’ activities on a regular, continuous, and substantial basis during 2008. As you can see, the 500 hour test is very objective while the second test is extremely subjective. The Tax Court decided to rule on the second test and agreed with the taxpayers. Based on his 237 phone calls with the plant during the year, his development of a new product, etc. the Court agreed he materially participated in the business.

Most cases involving passive/material participation involve the more objective tests. It is nice to see that a subjective test went in the taxpayer's favor. If you are involved with a farm S corporation, partnership or LLC and work in the operation more than 100 hours or less than 500 hours, make sure to document how you meet this test. If you do, you will be able to keep you tax savings.

Mid West Crop Tour 2014

Aug 14, 2014

Pro Farmer conducts a Mid West Crop Tour each year. There are two legs to the tour. The Eastern Leg starts in Columbus, Ohio this Sunday night and on Monday, about 11 routes are conducted from Columbus to Fishers, Indiana. These routes will go over the exact same roads as in previous years, however, the fields scouted will be at random. We usually stop about every 15-20 miles to get a sample and try to get at least one sample in every county. Tuesday, we go from Fishers to Bloomington, Indiana. On Wednesday, we head over to Iowa City, Iowa and then finally head up to Rochester, Minnesota where we finish the tour.

The Western Leg starts in Sioux Falls, South Dakota, goes the first day to Grand Island, Nebraska. The second day scouts the rest of Eastern Nebraska and ends up in Nebraska City, Nebraska. On the third, day we head up to Spencer, Iowa catching all of Western Iowa and on the last day catch Southern Minnesota and meet up with the Eastern Leg at Rochester.

Each night, there is presentation to local farmers on the results of the tour and Pro Farmer will report their estimated yields for each section they cover during that day, etc.

I have participated on the Crop Tour for the last four years and this year will be my fifth tour. This really comprises my summer vacation (I know some of you think that is a sick way of doing a summer vacation, but there are enough of you out there to understand my addiction).

The participation by the scouts on Twitter has gotten greater each year and due to the large anticipated crop this year, I am expecting the Twitter feeds to be at an all time high. If you want to follow my Tweets, my Twitter handle is @FarmCPA and the Hash Tag should be #pftour14. If that is not correct, I will post an update.

I should be posting a recap of each day as it occurs. Sometimes, the evening activities get a little hectic and I might not post until the following morning, but I will keep you updated next week.

Sale of Gifted Grain Can Be Tax Free

Aug 13, 2014

We had a reader ask the following question:

"We want to gift our daughter (she is not a dependent) some grain that is from the 2012 growing season. We plan to have the elevator issue her a contract to show ownership and then she can call them and sell the grain when she is ready. She will sell the grain this tax year. My question is: Because we have already held the grain for over a year, does she qualify to take the income as a capital gain or will she have to take it as ordinary income? "

When a farmer gifts grain to a child or grandchild, the basis in the grain carryovers to the donee. If the grain was harvested in the prior year, then the cost basis is zero. If the grain is donated in the year of harvest, then the farmer must allocate a portion of their expenses to the donated grain. Therefore, most farmers try to make sure to donate previous years grain.

When the donee sells this grain, it will be reported as a capital gain. If time after harvest of the grain and the time of sale is less than a year, it is short-term. If this time is greater than a year, then it is long-term. It does not matter how long the donee/child owns the grain. What is important is the time from harvest until sale.

If the child is a dependent of her/his parents, the kiddie tax rules apply which means we have to pretend that the child's income is added to the parent's income to arrive at the correct tax liability.

In the case of our reader's question, we know that the grain was harvested in 2012. Therefore, the holding period is at least a year plus, so we know this is long-term capital gain when the daughter sells the grain. The reader also indicated that the daughter is not a dependent, therefore, if the gain from the sale of the grain falls with the 15% tax bracket (up to about $36,000 of taxable income for a single taxpayer), then the capital gain will be taxed at a zero rate. This will most likely result in the daughter paying no federal income tax on the gain (unless she has a fair amount of other income). Most likely the worst case is the gain will be taxed at 15%. Additional state income taxes would apply.

This is one more reason why it is a great idea to gift grain to your children. It reduces your income and self-employment taxes and in many cases if the grain is held long enough, the gain will be tax-free to the child and taxed at favorable capital gains rates (even if the kiddie tax applies).

Three Years is the Normal Statute of Limitations, But Not Always

Aug 12, 2014

I get a phone call or email many times during the year asking how long a taxpayer needs to keep documents. The answer is "it depends" as is usually the answer for all tax questions. The IRS generally has three years from the due date of your tax return to assess additional tax. Therefore, if you filed your 2013 tax return without an extension, the IRS has until April 15, 2017. With an extension, the date would be October 15, 2017.

Now, in the case of fraud (assuming the IRS can prove fraud), the IRS has six years to assess additional tax. Now, if you invest in a partnership that is subject to certain rules that were put into place many years ago, this 3 or 6 year period can be dramatically longer as was shown in an US Tax Court case released today.

In the McElroy case, the taxpayers had invested $37,500 each year during 1996, 1997 and 1998 in partnerships. The partnerships took the money from the partners, acquired cemetery sites, held them for a year and then donated them to qualified cemeteries to pass through a charitable donation. For example, in 1999, the partnership acquired sites with a value of about $95,000. Without waiting a year, the partnership then donated the sites and then passed-through to the partners a charitable donation of $1,864,850 or about 20:1. As you can probably guess this was sham and the operator of the partnerships suddenly found himself in hot water and finally ended up serving some type in the Federal Pen.

The taxpayer had invested $37,500 each year expecting net tax benefits of at least $50,000 a year. He filed his returns and the normal 3 year statute passed fairly quickly. The partnerships were subject to rules passed back in 1982 that required a tax matters person (TMP) to be appointed. That person was Mr. Johnson who agreed with the IRS to extend the statute of limitations through 2008 as the TMP for the partnership. After being sent to jail, the TMP was transferred to Mr. McElroy who continued as the TMP until he declared bankruptcy in 2010.

The partnership audits were finally settled in 2013 (at least 15 years after the first individual return was filed) and the IRS then assessed additional taxes on Mr. McElroy. He claimed that the statute of limitations had expired clear back in 2002. However, one of the nasty features about these types of partnerships is that any item that is ultimately resolved at the partnership level is then passed through to the partner (assuming the IRS assesses the liability within a year of the final assessment). That happened in this case and the Tax Court agreed with the IRS that Mr. McElroy owed the additional tax assessment even though it happened more than 15 years after the deduction.

When investing in any partnership where you are a limited partner or member, the fine print will usually spell out the possibility of this happening, although most people never read or understand those sections. Therefore, this can happen to you. If you invest in a partnership that promises substantial tax benefits; don't breathe a sigh of relief when the normal three-year statute of limitations passes since you may be required to pay your tax savings plus interest plus penalties more than 15 years down the road.

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