Effective tax planning is similar to pro football. They each have three seasons: preseason, regular season and postseason.
Preseason. Pro football’s pre-season consists of four games that do not affect the final win-loss record for the season. Each team tries out new players and at the end of the four games cuts those who do not have a role in the final team.
Likewise, during this preseason of tax planning, the farmer plays "what-ifs" to see how they affect his current and future years’ tax plans. For example, in 2011, 100% bonus depreciation is allowed on new equipment and farm buildings placed in service during the year. The farmer will run multiple calculations to see how this bonus depreciation affects his taxable income for this year and down the road. One scenario might result in no tax owed for 2011 but much higher taxes in 2012 and beyond. Another scenario might result in higher taxes in 2011 and much lower taxes in 2012 and beyond. The farmer runs his tax "plays" to see how the income tax "competition" will defend and picks the one that "scores" the most.
Regular Season. When he is playing on offense during the regular season, the farmer calculates the amount of taxable farm sales he will generate by year-end. On defense, he calculates the cash deductions he will incur before year-end, as well as the amount of tax depreciation he is allowed,
to arrive at a score for the year. After determining this score, he considers all of his other income and deduction sources to arrive at his final "taxable income" score.
As in football, the farmer strives for his offense to score more points than the other team. Effective tax planning normally results in paying some taxes each year. The game plan during the regular season is to smooth out your taxable income as much as possible and take advantage of income tax deductions and exemptions.
Postseason. The farmer’s postseason begins on the first day of the new tax year and lasts until he files his tax return for the previous year. During the postseason, the farmer calculates the final score and then determines what adjustments are needed to win the game.
There are many elections that a farmer can make after year-end to adjust his taxable income. For example, say that during the regular season, a farmer enters into four $20,000 contracts on corn delivered in 2011, with payment to be received in 2012. During the postseason, the farmer determines his taxable income is only $40,000, but he wants it to be $80,000. He can elect to report two of the contracts as taxable in 2011 and adjust his taxable income to $80,000.
During the regular season, let’s say, the farmer applied fertilizer in the fall. In the postseason, he can elect to capitalize $40,000 of the fertilizer costs and thus not allow the deduction until later years, when the fertilizer benefits are received. Either of these two methods results in the same adjustment to taxable income.
Another play during the postseason is determining the right mix of Section 179 and bonus depreciation for the year to help you reach the right end zone.
The Final Score. If the farmer has effectively prepared his "tax team" during the three seasons, he will usually have a winning score when filing his tax return. If he has not done any planning, the opposing team will determine his score—and it won’t likely be in the farmer’s favor.
Paul Neiffer is a tax accountant with LarsonAllen LLP and author of the blog The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at firstname.lastname@example.org.