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January 2013 Archive for 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.

The Board is Not What it Used to Be!

Jan 30, 2013

Today was the first day of the Top Producer Conference.  The first session was very interesting.  Dr. Tom Deans, author of Every Family's Business gave a talk on how many farmers really should be looking at "selling" the farm instead of "gifting" the farm.

Too many times, the gift of the farm ends up creating inter-family squabbles, while a sale, either to family or outside parties can greatly reduce this risk.  Definitely food for thought.

I then headed over the Chicago Board of Trade to meet up with Thomas Grasifi of Indiana Grain Company.  He took me down the floor and it became very apparent that trading has changed dramatically.  The pits where futures are traded were just about empty.  We spent some time at the corn options pit which was very interesting.

We then came back down for the close of the meats at about 1 pm and for about 2 minutes you could hear the roar from the pit action and then it was basically done for the day.

At 1:15, the Fed had their announcement and you had action in gold, financials and the equity indexes till the close.

Almost all of the futures trading is now electronic and it may not take much longer for more of the options, etc. to be done this way.

File Your Return After March 1, Not Before

Jan 30, 2013

Even though the IRS granted relief for farmers to file their tax return by April 15 of this year, there is a "gotcha" in the details.

If you file your return on or before March 1, 2013, you must also payyour tax on or before March 1.  If you file on March 1 and then pay your tax on April 15, you most likely will be subject to the penalty.

Therefore, to file and pay your tax without the penalty, make sure to file between March 2 and April 15, 2013.  Otherwise, you may owe a penalty you were not counting on.

Tomorrow Top Producer Part 3

Jan 29, 2013

 The next session involved three active farmers, Chris Barron from Iowa, Dick Wittman from Idaho and Michael Daniels from Wisconsin. 

First question was how their growth strategy has changed?  Chris responded with what is the definition of growth?  Is it profits, acres, etc.

Dick asked how many farmers have a defined growth strategy and not many farmers raised their hands. It is important to clearly define it and write it down.  Their acreage base is averaging about 7% a year to keep up with the technology and other changes.

Mike indicates he wants to grow with dignity. Not the biggest but more the best. Look for opportunities that may not be strictly farm related. Can you add other operations to your farm such as construction, trucking, custom farming, etc.

Employees are needed to become "owners".  How can you work toward that goal. 

 

Tomorrow Top Producer Part 2

Jan 29, 2013

 Bret Oelke with the University of Minnesota spoke on Building Meaningful Business Relationships. 

You need to view all of your relationships as dealing with a customer. Your customer is your employee, input providers, landlords, etc.

Your internal customers are employees, employers, partners and family members.  Family members want your time more than money at times. 

Always ask the question when you are dealing with someone is "how are they paid". Once you know this answer you will know how to better interact with them.

For external customers know the following:

  • Understand what they need from you
  • Be responsive to their needs
  • Lower transaction costs
  • Don't waste their time

 

Be the farmer who they call to meet their needs.

Tomorrow Top Producer Conference Observations

Jan 29, 2013

Brent Gloy from Purdue University spoke on What's Ahead for Young Farmer.  One observation was the expectation by most farmers is that corn prices will range from $5 to $7 per bushel for the next five years. What happens if this number is $2 lower on average. How would your farm react to this.

He has expectations that we are entering a bubble period, but like everyone cannot tell when it will pop.

Young farmers need to invest in management excellence before jumping on the next piece of land.  Be ready for the time period when nobody wants to buy a farm.

Brent thinks the "cash" buyers maybe tapped out in this market and the leverage buyers may come next. He hopes that this will not happen. Lenders are getting pressure to up their borrowing capacity. If this loosens the bubble will bubble even more. Credit is there for good times but can be pulled in bad times. 

Farmers need to make sure not to misallocate scarce capital. Do not overpay for fixed assets or buy at any cost. Does it make more sense to custom farming. Also don't bank on the next five years being as profitable as the last five. 

 

AMT Causes A Few More Capital Gains Tax Rates

Jan 24, 2013

We had a reader send in the following question:

"Do long term capital gains count in determining AMT? And thus potentially increasing 15(20) percent effective rate?"

We wrote a post a couple of weeks ago about there being ten different long-term capital gains tax rates beginning in 2013.  Well, we can probably at least two or three more for the effect of Alternative Minimum Tax (AMT) on our effective rate calculations.

The good news is that AMT taxes long-term capital gains and qualified dividends at the same rate for federal income tax purposes.  The bad news is if your income is at a certain level, each additional dollar of capital gains phases out 25% of your allowed AMT exemption.  Without getting too technical, this means that for 2013, if your AMT income is between roughly $75,000 to over $300,000 depending on your filing status, this may apply to you.

For example, assume a married couple is in the range where the phase-out applies and their adjusted gross income on the tax return is $250,000, with $10,000 of capital gains.  Since they are below the net investment income tax (NIIT) threshold, their capital gains tax rate is 15%.  However, this extra income caused $2,500 of their AMT exemption to phase out and the net effect on this is either $650 or $700 (depending on their AMT rate).  This makes their effective capital gains tax rate either 21.5% or 22%. 

Now if we bump their income over the NIIT threshold, this increases their net capital gains tax rate by another 3.8% pushing it up to 25.3% or 25.8%. 

Now on top of it, if we have the 3% of itemized deductions apply to their AMT situation (sometimes it won't), then the final maximum rate could be almost 1% higher.

As you can see, depending on their overall AMT situation, their net capital gains tax rate could be as low as 15% or as high as almost 27%.  Since the AMT exemption is usually fully phased out when the maximum 20% capital gains tax rate kicks in, we won't quite get over 30% due to AMT.

Since it looks like we can have three additional capital gains tax rates due to AMT, I think we are not at an official bakers dozen (and it is really more than that based on your number of personal exemptions claimed on the return).

Why Imputed Interest Matters for 2013 (And Beyond)

Jan 23, 2013

Any time a farmer loans money to a corporation that they own (or vice versus), the income tax laws require these loans to bear interest.  If the loans do not bear interest, then the law requires the farmer to calculate an "imputed" interest amount based upon the applicable federal rates published by the IRS each month.  Lately, these rates have been very low (less than 1%).

In the past if the farmer loaned money to an S corporation and did not charge interest, the imputed interest rules normally did not affect the bottom line tax.  The amount of interest income the farmer would report would be offset by the same interest deduction reported on the S corporation.  However, if the S corporation had loaned money to the shareholder, it would change the bottom line tax since the interest "paid" by the farmer would usually be non-deductible.

With the imposition of the 3.8% net investment income tax (NIIT) for this year, this is no longer true for higher income farmers.

If your adjusted gross income (AGI) is $250,000 or less ($200,000 for singles) this tax does not apply.  However, if your AGI is over these levels, then the imputed interest will create an additional 3.8% tax on part or all of this income even though your AGI does not change.

Let's take a look at some examples on how this works.

Suppose, we have a farm couple with exactly $250,000 of AGI.  In this case, their income tax is $52,213.  They owe no NIIT since their AGI is exactly $250,000 (remember NIIT is computed on the LESSOR of net investment income or AGI minus $250,000). 

Now let's impute $10,000 of interest income on loans they made to their S corporation.  In this case, they have net investment income of $10,000 subject to the 3.8% tax, but their AGI is still $250,000.  It went up by $10,000 of imputed interest income reported on their Schedule B, but the S corporation income went down by the same $10,000, therefore, they do not owe the extra $380 of NIIT since their AGI still is not over $250,000.

Now let's assume this is a regular C corporation.  In this case, the farm couple would owe the $380 of NIIT since their AGI went up by $10,000 and the offsetting deduction is reported on their corporation, not their personal return.

Let's assume their AGI was $255,000 with no investment income.  With the imputed interest of $10,000, they now have investment income of $10,000, but since their AGI is still $255,000, their NIIT is only $5,000 time 3.8% or $190.

Let's assume their AGI was $260,000 with no investment income.  In this case, the $10,000 imputed interest will be subject to the full 3.8% NIIT since the difference in AGI and net investment income is exactly $10,000.

The rule of thumb is if your AGI is less than $250,000 before imputing interest, then imputing interest will not create the NIIT (assuming a loan to an S corporation).  If the amount of AGI over the $250,000 is less than the imputed interest, then only this amount is subject to the tax and if this amount is greater than imputed interest, then all of the imputed interest will be subject to NIIT.

This is just another added layer of complexity that many farmers will face this year.  Since these applicable federal rates are extremely low right now, it makes sense to "lock" in these low rates so minimize the imposition of this new tax.  Talk to your tax advisor now.

It May Pay to Fill Out Your Ag Census Online

Jan 22, 2013

Every five years the Department of Agriculture sends out a very detailed census form for farmers to prepare and send back.  We have already discussed this form with several farmers and as usual it can be very hard to follow the paper form.  We have found preparing the form online can save some time and frustration.

This is primarily due to the computer automatically taking you to the next part of form based on how you fill out each answer.  This is not true in all cases, but based on our feedback, the online version seems to create less frustration.

This census does provide valuable information to the Department of Agriculture, and thus, should not be ignored.

Are Taxes Progressive in the US?

Jan 21, 2013

Every once in a while we read an article on either how progressive or non-progressive our tax system is in the US. We ran across this article while browsing the Internet and the first thing that struck me is how the word progressive is denoted in these articles as being equal to percentage.

In the article, the author strives to indicate that the richest 1% barely pays more tax than those in the lower income brackets since their overall percentage of income paid to taxes is not much more than lower income earners. They state that even though the federal income tax structure is progressive, all of the other taxes such as payroll taxes, excise, sales, property and other taxes are clearly regressive (in their opinion).

For example, the article states that the lowest 20% of taxpayers pay on average about 19% to taxes. The highest 1% only pay about 29% and the overall average is about 28%.

What the article fails to point out is the amount of overall taxes paid by each bracket. For example, the lowest 20% bracket pays about $2,262 of total taxes, while the upper 1% pays almost $400,000 or about 200 times higher than the lower 20%. The average for the "bottom 99%" is about $16,000 which again is about 25 times lower than the 1%.

As with most of these articles, it is very easy to take a statistic and slant it one way or another using percentage in one case and actual dollars in another. The point is to understand both sides of the spectrum so you can make a more informed decision.

KC Fed Reports Drought-Reduced Income Boost Farm Loans

Jan 20, 2013

The Kansas City Federal Reserve Bank just released their third quarter Agricultural Credit Conditions report.  The report indicated that the drought caused lower farm income for the quarter which caused farmers to increase their farm operating loans.  Capital spending plummeted in the quarter.  This could have been caused by the drought or perhaps the lower Section 179 limits and 50% bonus depreciation may have already reduced farmers appetite for more equipment.

The sharpest income declines emerged in cattle feedlot and hog operations.  With the drought, feed prices appreciated over the previous year and quarter and summer pasture dried up.  The bankers also reported that corn and soybean income fell below last years levels, however, wheat farm income was actually higher than last year.  The drought came too late to affect wheat production.

Bankers expressed concerns about the drought effect extending into 2013.  The spike in feed costs has already resulted in some herd liquidations.  The reported closing of a Cargill beef plant in Texas last week is probably primarily caused by these conditions also.

Bankers reported the steepest quarterly increase in farm loans since the first quarter of 2010.  This was offset with the lowest demand for equipment financing since the same early 2010 period.

Even with the drought, farmland prices continue to rise.  The district saw a 24% overall rise in non-irrigated farmland with Nebraska leading at 30% with Kansas and Missouri right behind at 22-23%, respectively.  About three-quarters of the bankers thought that farmland values would stabilize for 2013.

IRS Announces April 15, 2013 Farmer Deadline

Jan 18, 2013

The IRS announced today in Issue Number IR-2013-7 today that due to the extended processing time for many tax forms including form 4562 (Depreciation), that the deadline for any farmer and fisherman has been extended April 15, 2013 from March 1, 2013.

To take advantage of the extended due date, the farmer will file out form 2210-F (which they normally already due when filing on March 1) and check the waiver box and attach it to the tax return. Nothing else will be required.

It would have been nice to make this announcement before the farmer estimated tax payment was due three days ago, but it is better to make the announcement now than to wait until near the March 1 deadline.

Much kudos to the National Farm Bureau for all of their support and Senator Grassley writing his letter. Without their help, this most likely would have taken longer.

Watch Out For Those Retroactive State Tax Gotchas!

Jan 17, 2013

We just read an article in the Xconomy website on a drastic retroactive law change specific to the state of California that will possibly impact many taxpayers.  Federal law has a rule under Section 1202 that allows you to deduct a certain percentage of your gain from investing in Qualified Small Businesses (QSB).  We won't go into all of the details, but in general, this deduction is 50% (in some years 100%).  The state of California decided many years ago to enact a law essentially similar to the federal law.

In the article the author explained how the state lost a Court case that challenged part of the law requiring QSB's to maintain a certain amount of the business in California.  The Courts finally ruled that this part of the law was unconstitutional.  When parts of income tax law are rule unconstitutional, etc. the state or federal government normally changes the laws to make it correct.

HOWEVER, the Franchise Tax Board in FTB Notice 2012-03 decided not to correct the issue, but rather, retroactively demand payment for any income tax refunds granted since January 1, 2008.  This means that if someone deducted $1,000,000 of gain on their 2008 tax return and saved about $45,000 in tax, they will be required to pay this back to the state.

Here is their very convoluted reasoning for disallowing the deduction:

Federal income tax law provides for the exclusion or deferral of gain from the sale or exchange of qualified small business stock (QSBS). Beginning in 1993, California adopted its own standalone QSBS provisions dealing with exclusions, which generally mirrored existing federal law. However, California law required that at least 80 percent of the company's payroll at the time the stock was purchased must be within California and 80 percent of assets and payroll must be within California during the taxpayer's holding period for the stock in order to qualify for a QSBS gain exclusion or deferral. In 1998, California adopted its own standalone QSBS provision dealing with deferrals.

The provisions in California law regarding the 80 percent asset and payroll requirements were found to be unconstitutional in August 2012 by the California Court of Appeal in Cutler v. Franchise Tax Board (FTB). The court's decision made California's entire QSBS statute invalid and unenforceable. As a result, all QSBS gain exclusions and deferrals previously allowed under California law became invalid. It is important to note that the court's decision in Cutler did not change the federal treatment of QSBS.

Because QSBS gain exclusions and deferrals are no longer valid for California purposes, taxpayers who previously took advantage of California's preferential treatment of QSBS in years still open for assessment under the four-year statute of limitations (generally 2008 and later) must now recompute their taxable income for each affected year without excluding or deferring gains from the disposition of QSBS. For 2007 (and prior) tax years still open under the statute of limitations, a QSBS gain exclusion or deferral will be allowed if the taxpayer meets all other requirements under California law, i.e., those other than the 80 percent asset and payroll requirements (See FTB Notice 2012-03).

This is probably one of the most egregious retroactive tax increases that we have seen in a long time.  None of the taxpayers did anything wrong, rather the State decided they would lose too much money and simply took away the benefit granted to taxpayers over a 4 year period.

We think as states need more and more revenue, you may see more cases like this (especially in California).

Senator Grassley Wants Extension of March 1 Filing Deadline

Jan 16, 2013

Senator Charles Grassley of Iowa released a letter yesterday to both Timothy Geithner, Secretary of the Treasury and Steven Miller, Acting Commissioner of the IRS urging prompt attention by the IRS to extend the March 1, 2013 filing deadline.  As many farmers know, they can file and pay by March 1 without having to make any estimated tax payments on January 15.

Due to the passage of the new tax law, the ability of the IRS to accept most farmers tax returns by March 1 is very uncertain.  Senator Grassley's letter indicates that the IRS has granted an extension in the past, most recently last year when the MF Global mess occurred.  In that case, the IRS did not actually extend the filing date, but granted waivers of the penalty for any estimated tax penalty caused by MF Global untimely mailing of form 1099.

This year, the possible delay is not caused by simply one organization going bankrupt, but rather by the complete lack of appropriate timing by Congress in passing the new law.  This has caused the IRS to delay acceptance of any tax returns until January 30 and most farmers until late February at the earliest.

We hope that Senator Grassley's letter will have the weight needed to get the IRS to issue a notice timely that will allow farmers to (1) know when their returns are due and (2) give them enough time to properly prepare the return based upon the final release of the IRS forms.

We will keep you posted.

IRS Announces Needed Relief on Home Office Deduction!

Jan 15, 2013

Many farmers and other small business owners operate their business out of their home. The tax laws allow a deduction for part of the expenses related to the home such as insurance, utilities and repairs based upon the square footage of the business portion to the total home size.

For example, if the farmer uses a 200 square foot room in a home with 2,000 square feet, the farmer would be allowed to deduct 10% of their home expenses that are otherwise non-deductible plus 10% of real estate taxes and home mortgage interest. This deduction reduces self-employment taxes. They are also allowed to depreciate part of their home in addition to the other allowed deductions.

The major drawback to this deduction is the amount of time and effort spent in arriving at the deduction. The IRS has been aware of this issue and today finally released a new Procedure to help reduce this burden.

The safe harbor election allows a taxpayer to simply determine the amount of square footage used for business (which is already reported on the tax return normally) and multiply this by $5 with a limit of 300 square feet or a maximum $1,500 deduction. Additionally, the total amount of real estate taxes and home mortgage interest is then allowed to be deducted fully on Schedule A. However, no depreciation or other deductions (such as insurance, repairs, etc.) is allowed as a deduction.

This election is voluntary each year. You can take actual one year, the safe harbor the next and then revert back to actual.

The normal rules related to qualifying for the deduction still apply.

In many cases, the next deduction found on many of these returns is much less than $1,500 and this may actually resulted in a higher deduction with minimal effort.

This safe harbor deduction is not allowed on your 2012 tax return, but you may start using it for 2013.

We Wonder What the Investment Income Tax Form Will Look Like?

Jan 14, 2013

Several of our posts have discussed the new 3.8% net investment income (NII) tax created by the 2010 Health Care Acts that will apply starting in 2013.  The IRS has issued proposed Regulations on how to calculate this tax and needless to say, these Regulations are long and complex.

After reviewing the Regulations, it appears the IRS will need to create at least one more long tax form to calculate this tax due to the following:

  • First, income from interest, dividends, rents, royalties, annuities and other such income must be accumulated into one bucket.
  • Second, income from passive activities and trading of financial instruments and commodities are accumulated into another bucket.
  • Third net gains from the sale of investment assets must be accumulated into the final bucket.  These net gains do not include the gains from the sale of business assets such as farm machinery, but include net gains on most other investment assets.  If the taxpayer ends up with a net loss for year, their calculation of net gains is then limited to zero.  For example, if the taxpayer has a net capital loss of $3,000, they can deduct that for regular income tax purposes, but not for NII.  As long as net investment income is greater than the excess of gross income over the threshold level, the taxpayer is not negatively impacted.

 

As an example, assume a taxpayer has $25,000 of net investment income and modified adjusted gross income of $270,000 after deducting a $3,000 net capital loss.  The NII subject to tax is the lessor of $25,000 or $270,000 less the $250,000 threshold level or $20,000.  Without the $3,000 capital loss, the amount subject to the NII tax would be $23,000.  In this case the $3,000 capital loss has reduced the NII tax.  Now, if modified adjusted gross income was $300,000, then the full $25,000 net investment income would be subject to the tax.  In this case, the capital loss has not reduced the NII tax.

After calculating all three of these buckets, the taxpayer then has to determine how much of their itemized and other deductions that are related to investment income are allowed as a deduction.  These calculated deductions reduce gross investment income to arrive at net investment income.

There are even more complex rules for the sale of an interest in partnerships and S corporations that we will not go into here, but as you can see, this may require an extremely complex form to be filled out and as usual increase the complexity and cost of filing your tax return.

These are proposed Regulations and the IRS is accepting comments through March of this year.  We hope some of the more complex parts of these Regulations will be removed, but we suggest not getting your hopes up too much.

Certain Credits Can Offset AMT

Jan 13, 2013

Part of the ongoing Alternative Minimum Tax (AMT) mess over the last several years involved the allowance of certain nonrefundable individual tax credits such as the adoption credit, the child and dependent care credit, the lifetime learning credit and other similar credits to be allowed to reduce AMT. In some years it was allowed whereas in other years it was not allowed or was only allowed on a retroactive basis.

In some years if a taxpayer had regular tax before these credits of $10,000 and AMT of $7,000, they could offset $10,000 of tax and potentially have zero tax liability. In other years, they could only offset $3,000 of regular tax and still be subject to the AMT of $7,000.

The new tax law passed at the beginning of the year now makes the more beneficial treatment permanent (at least as permanent as Congress will allow). This rules has been made effective as of January 1, 2012.

Therefore, along with the increase in the AMT exemption to reflect inflation, taxpayers can now offset AMT with nonrefundable personal credits that might not have been allowed under the old law.

On another subject that appears to be raising its head is that possible limitation of 2013 direct payments. Although Congress passed a one-year extension of the 2008 farm bill; with the upcoming fight over the debt ceiling and sequester issues, there is a distinct possibility that these direct payments will be reduced or eliminated. The possible savings in the current and future years may be too tempting for Congress to pass up. We will keep you posted.

Section 179 Can Create A Farm Loss (In Certain Situations)

Jan 10, 2013

We got the following question from one of our readers:

"Is it true you can only deduct Section 179 in the amount of your farm income remaining after other deductions? In other words you can not have a loss because of 179 depreciation? If the Section 179 deduction is more can you carry it over to next year?"

For Section 179, there is an overall taxable income limitation for deducting the 179 expense.  For an individual, this limit is based upon your overall global business income including the following:

  • Wages and salaries for the taxpayer and/or spouse,
  • Ordinary proprietorship (schedule C or F), partnership, or S corporation net income (or loss),
  • Section 1231 gains (or losses) from a trade or business (selling farm machinery for more than cost),
  • Depreciation recapture from the sale of farm or other business equipment.

 

All of these items are added together and this "taxable income" limitation will determine your maximum Section 179 deduction.

For example, assume a farmer has schedule F net farm income before Section 179 of $200,000.  He has $100,000 of wages earned from outside the farm.  He purchased $500,000 of equipment during the year.  He is allowed to deduct up to $300,000 of equipment under Section 179 on his schedule F resulting in a farm loss of $100,000 which is offset by his wages of $100,000.  In most cases, he would not want to take that much, but he is allowed to deduct that amount.

Without the wages, he would have been limited to a $200,000 deduction amount.

If the amount of Section 179 elected exceeds this taxable income limitation, then the excess can be carried forward and used in the next year (subject to these limitations, etc.).   As discussed in previous posts, if you carry too much forward, you may permanently lose the deduction.  You do not want that to happen.

As usual, you should discuss this with your tax advisor.  We have seen many returns with the wrong amount of Section 179.  Make sure yours is correct.

Don't Forget The Double Payroll Tax Hit!

Jan 10, 2013

Many farmers are aware that the FICA rate for employees (including their employee portion, if self-employed) has gone back to the old 6.2% which is up 2% from the temporary reduced 4.2% rate for 2011 and 2012.  This increase applies on wages as paid and will also apply on any self-employment income paid with the tax return.

The other tax that may get lost in the discussion is the new Medicare surtax of .9% on earned income in excess of $200,000 for single taxpayers and $250,000 if married filing joint.  If the farmer is employed outside of the farm or earns a wage from their corporation, the employer will be required to start withholding this extra tax once the $200,000 level is reached, even if the employee is married.  If the spouse does not work, then the couple may be entitled to a refund when they file their personal tax return if their total wages are less than $250,000.

If the farmer is self-employed, then this extra tax will be owed if they exceed the threshold amount.

This is another tax that has a marriage "penalty" built into it.  For example, two single taxpayers earning $200,000 each would owe no additional Medicare tax, but if they were married, they would owe the tax on $150,000 of earnings or $1,350.

IRS Announces When Tax Retuns can be Filed

Jan 09, 2013

The IRS just released a notice announcing that processing of returns will commence on January 30, 2013 for most individuals.  More complex returns will not be accepted by the IRS until late February or even into March, 2013 due to the complex changes to the IRS software system caused by last week's new tax law.

The notice mentioned specifically form 4562 (Depreciation) will not be available until that time period.  We know that almost 100% of our farmers have depreciation reported on this form.  We are assuming that the March 1 farmer filing due date may get delayed by the IRS, however, they have not specifically mentioned that yet in an announcement.

As we have discussed in numerous other posts, this year may be a perfect time for farmers who normally file by March 1 to simply make their required estimated tax payment (lesser of 100% of 2011 tax or 2/3 or this year's estimated tax liability) on January 15.  This allows the farmer to file on April 15 and pay the remaining tax that may be owed then without any additional penalty.

With all of the changes associated with the new law and associated tax planning for 2012 and 2013, the extra 45 days may come in handy.

In yesterday's post on S corporations, I became aware of one typo plus my discussion on installment sales was incorrect.  Here is a link to the updated post

Reprieve For S Corporaitons With Built-in Gains

Jan 08, 2013

Many farmers had C corporations with very low basis land in them.  As discussed in several posts, corporations with land face a double tax that in many cases can exceed 65% of the value of the land sold by the time the money from the sale is distributed to its shareholders.

One of the options to mitigate this tax is to convert the corporation to an S corporation and wait 10 years to avoid the Built-In-Gains (BIG) tax.  The BIG tax is assessed if you sell any appreciated assets with-in 10 years of converting.  This tax is based upon the highest corporate rate (currently 35%).

For S corporation returns beginning in 2009 and 2010, Congress changed the law from 10 years to 7 years.  They then changed it to 5 years for returns beginning in 2011 with the tax law passed at the end of 2010.

The new law just passed last week extends this 5 year period to returns beginning in 2012 and 2013.  Therefore, if you are an S corporation with BIG and have been an S corporation for at least 5 years at the beginning of your year, then you will not owe the BIG tax even if  you sell those appreciated assets.  The 10 year rule will apply beginning in 2014 (unless they change it again), so if your S corporation has been in existence less than 7 years at the beginning of 2011, you should sell any appreciated assets during 2011-2013 (assuming you plan on selling them), otherwise, you may be subject to the BIG tax in 2014.

One negative aspect of the new law is that if you sell appreciated assets subject to BIG on an installment sale, then all of the gain is reported as BIG income in the year of sale, not as the payments are collected.  This could subject more gain to the BIG tax than in prior years.

One positive aspect is that if you carry forward your BIG income to future years due to the taxable income limitations and the BIG period has expired, you will now owe any BIG tax on the expired amount.

This has been one of our more technical posts, but this situation applies to many farmers and you may want to plan accordingly.  As usual make sure to discuss this with your tax advisor.

Fiscal Cliff Tax Bill May Increase the Divorce Rate

Jan 07, 2013

Congress created laws several years ago to mitigate the effect of married couples paying a higher tax than two single people living together.  The extra tax was commonly known as the "marriage penalty".

The Fiscal Cliff Tax Bill passed last week has brought this marriage penalty back into existence and it appears to be even greater than in prior years.

For example, we ran some calculations on what the income tax (including the Medicare surtax on wages) would be for a married couple where each earned $400,000 in wages versus two singles earning $400,000 each.  We assumed a standard deduction for both cases.  There is no exemption deduction since both cases are over the threshold.

The married couple would owe about $260,000 of income taxes and another $4,950 of Medicare surtax for about $265,000 in total federal taxes.  Each single person would owe about $114,000 of income tax and $1,800 of Medicare surtax.  Doubling these amounts results in total tax for the two singles of about $232,000.

As you can see, the married couple pays about $33,000 of extra tax each year that they are married.  On the same amount of income, the married couple has an effective tax rate of 33% while the two singles have an effective rate of about 29%.  The married couples penalty is 4% of their gross income.

It would not surprise us to see the "divorce" rate for higher income couples increasing as compared to the prior several years.

Up to Ten Capital Gains Tax Rates for 2013!

Jan 06, 2013

After reviewing the various phase-outs of itemized deductions and personal exemptions based upon gross income plus the implementation of the new 3.8% investment surtax, for 2013 there now at least 10 different possbile maximum long-term capital gains and qualifying dividends tax rates.  The rates range from zero for that portion in the 10-15% tax bracket up to almost 25% for those taxpayers with income in excess of the 20% maximum capital gains threshold amount (currently $400,000 - single and $450,000 - married filing joint).

We worked up a quick chart showing what the maximum rates might be assuming various levels of gross income and taxable income.  It is extremely difficult to get this chart exactly right since part of the tax is based on adjusted gross income and part is based on taxable income.  It is designed to give you an idea what your actual capital gains rate may be for certain levels of income.  Unlike most tax planning based upon taxable income estimates where we know the rate, for capital gains taxes, you most likely will not know your exact rate until you file your return.

Also, if AMT applies in your situation, the rates associated with the phaseout of personal exemptions may not apply and part of the phase-out of itemized deductions may not apply also. 

Unlike 2012 where we had two maximim capital gains rates (zero and 15%), for 2013 it can be at least 10.

2013 Maximum Capital Gains Rates Examples

The above link provides an example of what the maximum capital gains tax rates would look like for a married couple with two children in 2013.  You will need to click the link twice to get it to come up.

Section 179 / Bonus Depreciation

Jan 04, 2013

Due to the passage of the new tax law this week, we have gotten several questions about Section 179 and bonus depreciation.  A couple of questions are as follows:

"Can you please expand on the extension of section 179?  For 2012, will the limits remain at $139,000/$560,000 or do they increase to $500,000/$2mil.  For 2013, are the amounts $139,000/$560,000 or $500,000/$2mil?"

"Will farm buildings such as shop or equipment storage buildings be eligible for section 179 or bonus depreciation for 2013?"

The answer on the first question is  that Section 179 for taxable years beginning in 2012 AND 2013 reverts back to the rules for 2010 and 2011.  This means that you can take Section 179 on new or used equipment of up to $500,000 in each year.  If you purchase more than $2 million of equipment in any one year, then the amount you can deduct is reduced dollar for dollar.  In 2014, the deduction reverts back to $25,000 (assuming no change by Congress).  The $139,000 amount originally proposed for 2012 has been eliminated.

On the second question, general farms buildings such as machines shops, barns, etc. are NOT allowed for Section 179.  However, single purpose structures such as a hog confinement facility are allowed to be deducted under Section 179.  Newly constructed farm buildings are allowed to use 50% bonus depreciation in 2012 AND 2013.  This provision is eliminated for 2014 (again subject to change by Congress).

The mechanics of how these rules interact is that you must take Section 179 first, then bonus depreciation second, and regular depreciation on what is left.

As an example, lets assume a farmer buys a new combine for $300,000.  He elects to take Section 179 of $100,000 first, then on the remaining $200,000, he is entitled to $100,000 bonus depreciation and finally, the remaining $100,000 has a depreciation deduction of 10.71% for the first year of  $10,710.  His total deduction for the year is $210,710.

Now let's assume the combine is used.  Using the same numbers, he takes Section 179 or $100,000, no bonus depreciation and $21,420 for a total deduction of $121,420 or about $90,000 less than a new combine.

In general, if you purchase farm equipment of less than $500,000 in 2012 and/or 2013, you will be able to deduct 100% of the purchase.  If you build a new shop or other farm building in 2012 or 2013, your net deduction for either year will be about 52% of the cost to build.

Some More Goodies Buried in the Fine Print

Jan 03, 2013

Included in the tax bill passed this week were some additional tax "goodies" for both farmers and non-farm taxpayers.

In previous years, taxpayers over age 70 1/2 were allowed to contribute up to $100,000 each year to a qualified charity and not have it count as income. The amount given to the charity was not allowed as a deduction, but this allowed the taxpayer to reduce their adjusted gross income which may have made their social security income non-taxable or allowed more medical or miscellaneous itemized deductions.

This has now been expanded through the end of 2013 which may help those taxpayers whose gross income is reaching or exceeding the level that the Medicare surtax will be assessed. For example, if a married taxpayer has $250,000 of cash rent farm income and is required to take $100,000 out of their IRA in 2013, $100,000 of their rental income will be subject to the Medicare surtax of 3.8%. However, if they elect to distribute the IRA directly to a charity, then none of the cash rent income will be subject to the Medicare surtax. Now this assumes that they would want to give up to $100,000 to charity.

Since nobody knew that Congress would extend this, they are allowing any taxpayer that normally meets the age criteria to take any distribution received in December 2012 and as long as it is paid to a qualifying charity by the end of January 2013, it will not be included as income.

Another extension is allowing taxpayers to amend a Section 179 deduction for any taxable year starting before January 1, 2014. We previously wrote a post about a week ago regarding being careful with Section 179 deductions from fiscal year flow through entities such as S corporations. Now that the Section 179 deduction limit has been increased to $500,000 for all years beginning before 2014, you will not need to worry about this until you file your 2014 tax return.

NASCAR fans will be glad to know that owners of racetracks will be allowed to depreciate these facilities over 7 years instead of the more normal 15 to 39 year span for at least another year. We have a combine racing facility in our state. I wonder if farmers could create a "qualified racing facility" on their farm and deduct it over 7 years (I hope everyone knows I am kidding about this. Do not attempt this!)

Some Major Tax "Goodies" in Senate Bill for Farmers

Jan 01, 2013

The Senate in the early morning hours of January 1, 2013 passed a bill to avert the "Fiscal Cliff". This bill is now headed to the House and it may be passed, not passed or amended and passed back to the Senate for further agreement.

Assuming that the Bill is passed as is, there are several major benefits to farmers included in the Bill:

  • The Bush tax rates would be maintained for income under $400,000 single and $450,000 married filing joint. For income in excess of these amounts, the rate would be 39.6%,
  • For those taxpayers in the 39.6% marginal tax rate, their maximum capital gains rate would be 20% (plus the 3.8% Medicare surtax, if applicable for a maximum 23.8% capital gains rate),
  • Permanently fixes the alternative minimum tax by increasing the exemption amounts to reflect inflation from the inception of the tax and includes an annual inflation adjustment to the exemption amount,
  • The lifetime exemption amount for gifts and estates would be permanently maintained at current levels ($5.12 million indexed for inflation, 2013 amount would be close to $5.25 million), however, the top rate would be 40% instead of the current 35%,
  • 50% bonus depreciation would be extended through the end of 2013,
  • A major increase of the Section 179 deduction to the old 2010/2011 level of $500,000 for 2012 and 2013 (farm equipment manufacturers will be very happy); this deduction will revert back to $25,000 beginning in 2014,
  • If you convert an S corporation in 2012 or 2013, the built-in gains tax only applies for 5 years, not 10 under the old law.

 

The phase-out of itemized deductions and exemptions for certain high income earners will be brought back into effect for 2013 and beyond.

Certain extenders have been temporarily extended:

  • The special exclusion for income from cancellation of qualified mortgage debt (through 2013),
  • The deduction for state and local sales tax (through 2013),
  • The exclusion from income of IRA donations to charity (through 2013). This one allows a "do-over" for IRA distributions received in December 2012, if they are transferred to charity before February, 2013. Also, for 2013, this may allow you to keep your adjusted gross income under the Medicare surtax levels,

 

The 2% reduction in the FICA rate for employees from 6.2% to 4.2% was allowed to expire. This will result in a payroll tax increase for all employed workers beginning today.

As we stated at the beginning of the post, this is not the law yet, but if a law is passed by both houses, it is extremely likely that it will retain most if not all of these provisions. We will keep you posted.

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