I am also celebrating a 30th anniversary—only as a CPA. This presents the ideal opportunity to recap some of the key changes that have occurred during the last 30 years in farm taxes and accounting.
In 1984, our firm just purchased a new IBM PC with dual floppies and a color monitor for $6,000. To use Lotus 123, you had to place the program floppy into one drive and then save your work to the other floppy. The internal memory was 64 kilobytes. Most farmers maintained a manual check register and brought it into our office to work up the tax return. This typically was the only time of year that the farmers knew their financial positions.
Today, farmers use computerized accounting systems and at the press of a button, they receive an updated balance sheet and other financial information. Many farmers use true accrual accounting to maintain their inventories and, again with a push of a button, can create a cash method statement for income tax purposes.
"With the recently imposed net investment income tax rules, an LLC might be the best vehicle for all farm operations."
Cash Method Continues. One of the greatest tax benefits to farmers during the last 30 years is Congress’ allowance of the cash accounting method. Farming has substantial inventory and most businesses with inventories are required to use the accrual method.
This allows farmers to defer income tax exposure for years or decades. This can have a positive bottom line impact, but deferring too much can have painful results. Working capital and marketing can be compromised. Top producers understand this concept and work to optimize deferral levels.
Entity Selection Changes. In the 1980s, most farmers operated in a sole proprietorship or corporation. Many farmers transferred their farmland into these corporations, which today are ticking tax time bombs because getting the land out of these corporations either by sale or transfer can easily cost 65% in federal and state income taxes.
About 20 years ago, the idea of a limited liability company (LLC) was created. These entities had the legal protection of a corporation, but could elect to be taxed as a sole proprietor, partnership or corporation. New farms today mostly use an LLC to at least own the farmland, and with the recently imposed net investment income tax rules, an LLC might be the best vehicle for all farm operations.
Drop in Top Tax Rates. The top income tax rate bottomed out in 1988 at 28%. Then it rose to the current top of 39.6% in 1993 under President Clinton, with an interim drop to 35% as a result of the Bush tax cuts in 2003.
The current top tax rate is likely closer to 45% for certain farmers. With the looming budget issues, these rates might go higher for farmers exceeding certain income levels. If this trend continues and corporation tax rates are lowered, more farms might incorporate.
For the last 10 years, the top corporate and individual tax rate were equal; there was little incentive to incorporate a farm. If the top corporate rate drops to 25% and the top individual rate exceeds 45%, the gap will provide plenty of incentive to incorporate.
Equipment Write-offs. Prior to 2001, bonus depreciation did not exist and Section 179 deduction limits did not exceed $25,000. Due to the Sept. 11 terrorist attacks, Congress created bonus depreciation to allow for immediate write-off of a certain percentage of any new assets purchased by farmers during the year. This bonus percentage started at 30% and increased to 100% for a couple of tax years.
Section 179 was expanded to $500,000 from 2010-2013. This has been a benefit to farmers; however, some might face a rude surprise if bonus depreciation is eliminated and Section 179 drops back to the smaller limits (2014 reverts to $25,000) and they find equipment depreciation deductions are not available to offset their income.
Several major farm tax and accounting changes have occurred during the last three decades. I expect even more changes during the next 30 years, and I look forward to helping top producers take advantage of them.
Paul Neiffer is a tax accountant with CliftonLarsonAllen 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.