When you’ve been involved with the agricultural industry as long as I have, you learn a thing or two about commodity cycles. The education I received working alongside my father and grandfather on our dairy, beef and grain operation has been invaluable during my 38-year career as an accountant.
I’m actually more of an educator than a bean counter. That’s why I’ve joined the Farm Journal team to provide farmers with the resources they need to create a tax strategy that’s mindful of their financial health.
As an accountant, I’ve helped farmers manage through three boom and bust cycles. I’ve learned that cycles come and go, but those farmers who pay attention to the details will thrive. Tax planning strategies are important. Managing taxable income to the point that you set a specific goal for your farm or ranch is minding the details.
Create a taxable income goal and adjust it annually based on economic conditions
No set rules. A couple years ago, I read somewhere that farmers and ranchers should target the 15% tax rate for taxable income. I couldn’t disagree more. Operations come in all shapes and sizes, which means the 15% tax rate won’t work across the board. Each operation should target a taxable income based on the size of the operation and other economic factors.
If you’re a young farmer, the 10% bracket might be appropriate. If you’re a mature operator who farms 2,000 acres and carries little debt, the 25% tax bracket might be the most appropriate. Attempting to drive the 25% target taxpayer into the 15% tax bracket will cause more problems.
It’s important to remember that you normally pay income tax on family living consumption and investments. I define investment as funds that are devoted to nonfarm assets and the net funds devoted to principal payments made on real estate debt.
Let’s work through the following scenario. You’re married, you’re the sole source of income for your family, you have no dependents, your family living expenses total $95,000 and you made principal payments of $10,000 on farm real estate above what the farm nets. You would need an adjusted gross income of $105,000 to meet your cash flow obligations under these conditions. As a result, these numbers would place you in the 25% tax bracket for 2013.
Another approach is to create a budget based on the size of your operation using average yields, prices and expenses. If you had an above-normal year, you would make expenditures or defer income to hit your "normal" income target. In years where you experience below-average income, you might want to accelerate income or defer expenses to prevent a spike in future income.
We create a taxable income goal for each of our farmer–clients, and adjust it annually based on the economic conditions or changes in their operation. For example, due to the increasing profitability for farmers since 2008, we attempted to limit the taxable income increase to 10% per year through 2012. However, when we were projecting taxable income for the 2013 tax year, we saw producers were carrying more bushels but less dollars into 2014. So we kept taxable income goals for 2013 the same as 2012 or even lower, depending on the individual operation.
Check again. Many people make the mistake of ignoring self-employment tax planning when considering tax obligations. Take a look at page 2 of Form 1040. If you’re a self-employed taxpayer, you might be surprised to find that you likely pay two or three times more for self-employment taxes than you pay in income taxes.
One size does not fit all farmers and ranchers. Develop a target income for your operation and make adjustments as your operation changes.
In the issues to come, I look forward to sharing tax resources and strategies. Send any questions you might have to email@example.com.
Tax Planning Tip
If you regularly experience a Schedule F income exceeding $45,000 and are under the age of 60, it might be beneficial to switch your operation to an S Corporation.
As an accountant, Darrell Dunteman focuses on helping farmers grasp tax complexities to craft a financially sound strategy.
Editor's Note: This column is not a substitute for seeking individual accounting advice.
- February 2014