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April 2010 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.

State Income Tax Refund can Create a 45% Tax Bracket or Higher

Apr 29, 2010

On of my favorite business magazines that I started reading as a teenager was Forbes.  This used to be a really great business magazine and it still fairly good, but with all the changes going on with the digital revolution, their web-site seems to be taking a higher priority than their magazine.  However, almost every issue has one or two good articles and in the most recent issue, there was an article on how getting a state income tax refund can create additional taxes.

I thought I would try to set up a real world example and see what type of tax rate we would end up with.  I set up a fictitious farmer couple with $125,000 of farm earnings, a rental loss of $25,000 and three kids under the age of 17.  In this example, their total federal income taxes was $10,244 for 2009. 

I then added in a taxable state refund of $15,000.  The farm couple probably overpaid their estimates for the year before and thought it was pretty good to get a nice size refund until they did their income tax return for this year.  The new federal tax bill for this couple went from $10,244 to $16,963.  This is an increase of $6,719 or an effective tax rate on this income of almost 45%, even though they are only in a 25% tax bracket.

The primary reasons for the increase is that they can no longer deduct as much of their passive loss and their child credit is almost cut in half.

Most farm families live in states with a state income tax.  You need to be cautious in paying this tax.  With most farmers, you usually pay both your federal and state income tax by March 1 and do not do estimates, however, in many states this might not be true.

Therefore, touch base with your tax advisor before paying any large state income tax estimates for the current year since you may get a large federal tax bill in the next year.

New Tax Credit for Health Insurance Premiums Paid by Farmers

Apr 27, 2010

Although I am usually on the other side from the IRS, I will admit that their web-site is one of the best sites I have used for accessing tax information.  The recent Health Care Reform law enacted a new employer credit for certain employers who pay for their employee's health care premiums.  I would estimate that 90% or more of the farmers will qualify for this credit if they pay their employees premiums.

To be eligible, you must be a small employer as follows:

  • You employ on average less than 25 full-time equivalent employees during the year.   The way to calculate this is to take your total paid employee hours (but subtract any hours for employees that work more than 2,080 hours in the year) and then divide by 2,080 (number of hours in a 52 week / 40 hour per week).  If the number is less than 25, you qualify, if more than 25, you do not qualify.
  • The average wage paid to your employees is less than $50,000 per year.  Again, you will most likely have to do this calculations using the FTE examples.
  • The employer must pay the health insurance premiums under a "qualifying arrangement".

A qualifying arrangement" is where the employer pays at least 50% of the employees health insurance (assuming a single employee).  The amount of the premium that is eligible for the credit is based upon the actual premium paid by the employer.  This amount is also subject to a cap based upon what the employer's premiums would have been for the small group market for their state (or states).  Also, if the employer pays 80% of the premium, then this cap is based upon 80% also.

The maximum credit for years 2010 to 2013 is 35%.

Let's take an example for 2010.  If the farmer employs 10 employees and pays and average wage of $24,000 and pays $45,000 in health insurance premiums for the year and this amount is more than 50% of the total health insurance premiums, the credit would be 35% of $45,000 or $15,750.

This credit is reduced if you employ more than 10 FTE or your average annual wage is more than $25,000.

In determining your FTE for the year, you do not include any seasonal employees which is based upon working less than 120 days during the year.

You do not include yourself or any of your family in arriving at determining FTE, however, you also do not get the credit for any of these premiums paid.

This credit is treated as a general business credit which means you have to have income tax to offset the credit.  If the credit is not used completely, the amount not used can be carried back one year and forward 20 years.

Another negative to the credit is that you must reduce your health insurance deduction by the amount of the credit.

For 2010, all employee health insurance premiums paid qualify for the credit (even though paid before the law was enacted).

In my opinion, a farmer who has more than $200,000 in taxable income will generally take advantage of the credit since they will normally be able to offset the credit against their income tax.  For those farmers with taxable income between $100,000 and $200,000, the credit will probably be better than the deduction, but certainly not in all cases.  For farmers under $100,000 of taxable income, in many cases taking a full deduction will be better than the credit since it will reduce self-employment income and in most cases, the farmer will not have enough regular income tax to offset the credit.

You will need to review this each year to determine which method works best for you.

The IRS has a more detailed question and answer memo on the credit.

What is Your New Dividend Tax Rate

Apr 26, 2010

For the last couple of years, farmers and other taxpayers have enjoyed a very low tax rate on dividend income.  This income used to be taxed at regular income tax rates (as high as 50% when combined with some state and city taxes).  However, starting a couple of years ago, the top rate on dividend income was 15% for federal and if you were in the 15% tax bracket, this rate was zero.

Beginning January 1, 2011, this special rate is scheduled to disappear.  The problem is that we are not sure what the new rate will be.  There is a chance that dividend tax rates will continue to be taxed the same as capital gains.  These rates are currently scheduled to go from 15% to 20%.  There is also a good chance that dividend tax rates will go back to the regular tax rates.

Under this scenario, the top tax rate on dividends would probably by 39.6% in 2011 and beginning in 2013, this top rate would go up another 3.8% if your income exceeds $200k or $250 for married couples.  This extra rate is due to the new Health Care Reform Law that was recently enacted.

In that law, the current Medicare tax of 2.9% on wages and self-employment income is scheduled to increase by .9% for people earning more than $200k or $250k for married couples.  In addition, Congress decided to make the Medicare tax due on almost all unearned income for those taxpayers making the same amount of money.

Therefore, there is potential for the top tax rate on dividends to go from 15% federal to a minimum of 43.5% (plus there are some other phase-outs that might get the top rate over 45%).

What does this mean for you for 2010.  The key thing is to review your income tax situation and if you have a C corporation, determine whether you need to distribute retained earnings a s a dividend to take advantage of the current low rates.  If you are in the 15% tax bracket, make sure to distribute enough dividends to soak up this tax bracket since they would be tax free.

Let's take an example of a farmer with a C corporation who is nearing retirement and wants to liquidate his corporation.  Lets assume there is $400,000 of retained earnings.  If they distribute the income in 2010, there total tax bill would be $60,000 (assuming no state income taxes).  If they wait until 2011, and pay the maximum rate, then the tax bill might be about $158,000 and if they wait until 2013, then the tax bill might be as high as $174,000.  As you can see, it makes sense to consider distributing the income this year.

We should know in the next few months what Congress plans to do, however, the surest thing I know now is that the dividend tax rate will most likely be higher in 2011.

Rural Economy Continues to Improve

Apr 22, 2010

Creighton University produces a monthly rural main street economic report based upon  a survey of bankers in an 11 state area which comprises most of the corn belt.  This survey gives a good picture of where the local farm economy is headed.

In the latest report, the highlights are as follows:

  • The farmland-price index moved above growth neutral for a third straight month to 59.5 from 58.2 in March.  After beginning a downward slide in the spring 2008, farm and ranch prices have once again begun to grow.  One banker reported that a 143-acre farm in Nebraska brought $8,025 per acre.
  • The farm equipment sales index soared from March 41.4 to 57.2 in April.  Bankers are reporting significant improvements in farm and ranch land prices and equipment sales.  They seem to expect these trends to continue in the months ahead.
  • One banker indicated the increases in cattle prices is having a large positive impact in the local economy.
  • For a second straight month, all bank indicators were healthy.
  • However, hiring in the rural area has yet to bounce above growth neutral.

Another interesting note was that about 82% of the bankers surveyed were in support of extending the 45-cent-per-gallon blender credit for ethanol production.  Only 8% were against it.

Watch Those Pesky Excise Taxes

Apr 21, 2010

About a year ago, I had a client that was involved in a small sub-division in the local area.  He was a 50/50 partner with another person.  The lots were listed for sale for about $45,000, however, the project was not quite complete.  With the downturn in the economy, the client decided to sell his 50% interest in the LLC back to his partner.  The consideration was no cash and the other partner would take over the debt.

The client went on his merry way until he got a call from the State of Washington wanting the excise taxes that he owed on the transfer.  In our state (and there are many others just like it), if you sell a 50% or more interest in an LLC during a 12 month period, then you owe the real estate excise tax on the full fair market value of the property excluding any debt.  Even though you only sold 50%, you owe the excise tax on the full 100% of value.

In this case, there were let's say about 50 lots advertised at $45,000, so the state assessed the excise tax of about 1.9% on $2,250,000 or about $42,750.  He had to pay  the whole excise tax even though not one of the lots had ever sold and the actual value of each lot was probably closer to $25,000 at that time.

Now, what I think is even more of money grab by the state is when the lots are actually sold, then the excise tax of 1.9% is, you guessed it, owed again.  There is no credit to offset any of the tax previously paid.

I now recommend that any of my clients that are involved in a 50/50 LLC and want to get out of the LLC, to only sell 49.5% of the LLC and wait over a year to sell the remaining .5% interest.

For many of our farmers who are doing succession planning to their children, they need to make sure to watch out for these excise taxes.

Harvest Time is Done

Apr 15, 2010

Just like a farmer coming to the last row of the last field of the fall harvest, today is my last day of what I call harvest time for CPA.  We have put in long hours since the first of the year (my last day off was on January 10), but this is my favorite time of the year.  Just like when I was growing up driving the combine was my favorite time.

I just want to wish my readers my thanks for their questions and feedback and now that things will be a little more back to normal, I will try to do more posts and keep the site going strong.

Thanks.

We Don't Want a Partnership - Part 2

Apr 11, 2010

In my previous post, I discussed a situation that applies to many farmers where there was joint ownership of land and whether a partnership tax return is required to be filed.  In that post, I indicated that in many cases, a partnership tax return is required and if one is not filed, then the penalty starting this year is much higher than it has been in the past.

With this post, we will review how to elect not to file a partnership tax return and the advantages to doing it.  In many cases, the mere co-ownership of farm land that is rented to a farm will not be classified as a partnership, however, it is very easy for the landlords to get tripped up in the process.  If the ownership is set up in an new LLC, then usually the IRS is going to assume the entity is a partnership.

The benefits of electing out of a partnership are as follows:

  • The owners may make tax elections that are different from each other;
  • The loss limitations at the partnership level will not apply;
  • You will not be required to file a partnership income tax return.  This can not only save you the cost of preparing a return, but in certain states such as California, the fee to file a partnership tax return (structured as an LLC) can be in excess of $5,000 annually.

If you have determined that you do not want to be a partnership, then the election must be made with the tax return in the year that you want to elect out of the partnership rules.  The partners must all consent to this election.  Even if you fail to make the proper election, it may nonetheless be deemed to have occurred if your facts and circumstances indicate that you intended to do this from the entity inception.

Another important rule is that this election is only available for passive farm rental operations.  If you are a farm partnership performing farm services, you can not elect out of the partnership rules.

My next post, however, will discuss allowing husband and wives to elect out farm operating partnerships.

We Don't Want a Partnership!

Apr 08, 2010

One of my readers sent me a question about a farming operation that applies to many farm families.  I am going to summarize the question as follows:

Scenario:

160 acre cropland is titled as Kevin XXX and Mary XXX, JTWRS (50%) and The Jane M YYYY Trust (50%).  Kevin and Jane M are brother and sister.  Mary XXX is Kevin's wife.  Kevin and Mary also have a 240 acre operation of their own.

Is a partnership return REQUIRED to be filed or can Jane M and Kevin XXX each allocate their share of expense/income attributable to the 160 acre operation.

Can you provide me some info?  What's the penalty for not doing it correctly.

As you can see from the facts, this is a fairly normal situation where property was probably inherited from a mom or dad and it is titled as co-owners in the brother (including wife) and sisters name.  The brother is also farming other property.

Normally, anytime property is owned by more than one party, a partnership of some type is involved.  This usually requires the filing of a partnership income tax return.  Until a few years ago, the penalty for not filing a partnership income tax return was minimal as long as all of the partners reported their share of the income timely.

However, with last year's new tax laws, the penalty for filing a late partnership income tax return can now be pretty steep.  The penalty is now equal to $195 per partner for each month that the return is late with a maximum of 12 months.  Therefore, under the current case, if a partnership return is required and they never file one, the IRS could assess penalties on three partners for twelve months at $195 per month.  This penalty would equal $7,020 which is substantial.

If the parties want to not to file a partnership return, then can make an election to opt out of the partnership rules.  I will discuss this election in a near future post, but as you can see, the penalty for not making the election can be substantial.

I will have a couple more posts on this subject over the next week or two.

Watch Your Real Estate Tax Bill

Apr 05, 2010

I think that most farmers know that the residential and commercial real estate markets have gone through dramatic changes in the last few years.  I know that in our area that residential prices peaked out about three years ago and in many of the cities near me the price is at least 50% below the peak.

Many would ask how that might affect you as a farmer.  The affect may come when you get your real estate tax bill for this year or next.   Most think that if the value of your property increases, then your property tax bill with increase or vice versus.  The reality is that it is the change in value of your property versus all other properties that determines your property bill.  Most of the taxes that are raised and paid by real estate taxes are of a fixed nature.  Therefore, the value of the property is just a mechanism to allocate the total taxes owed.

Lets take an example:

Suppose the county is raising $1,000 in taxes for the year and you have a farm worth $500,000 and your neighbor has a house that is worth $500,000.  This means that 50% of the total taxes raised will be allocated to each of you.  You are your neighbor will each pay $500.  Now lets say that your farm increases in value to $750,000 this year and your neighbor's house drops in value to $250,000.  Then your tax bill will go from $500 to $750 and your neighbor's bill will drop to $250.

In many states with large farmland concentrations, this valuation adjustment has already happened or may happen this year.  This means that your property tax bill may go up even more than the value of your land has risen.  There may not be much you can do about it, but you need to know that it can happen.

Bruce Johnson of the Department of Agricultural Economics from the University of Nebraska has a very good power point presentation on this issue for Nebraska farmers, however, the concepts apply to any farm operation.

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