Two Taxable Income Scenarios

November 16, 2011 04:54 AM

The following information is a Web Extra from the pages of Top Producer. It corresponds with the article "The Three Seasons of Tax Planning." You can find the article in the Top Producer Mid-November issue.

The pre-season starts to wind down about half way through the year when the farmer starts his regular tax planning season. This continues until the end of the year. When on offence, the farmer is calculating how much taxable farm sales he will generate by year-end. 
On defense, he calculates his cash deductions that will be incurred before year-end. He will also incorporate into his defense the amount of tax depreciation that is allowed to arrive at his final score for the year. After determining his farm score, he then has to bring in all of his other sources of income and deductions to arrive at the final “taxable income” score.
Just like football, the farmer is striving for his offence to score more points than the other team. Effective tax planning normally results in the payment of some tax for each year. Let’s assume a farmer has the following taxable income over four years:
  Scenario A Scenario B
2008 $100,000 $250,000
2009 $100,000 $-50,000
2010 $100,000 $300,000
2011 $100,000 $-100,000
Total Income $400,000 $400,000
If we were scoring this like a football game, the score for Scenario A would 4-0 and the best score for Scenario B might be 2-2 or even 0-4. The goal of effective tax planning is to smooth out your taxable income as much as possible and take full advantage of your available income tax deductions and exemptions. 
Although the total amount of income reported for the four years is exactly the same, Scenario B would most likely result in the loss of certain tax exemptions and may also increase the income tax bracket for the two large income years even if farm income tax averaging was used. Scenario A does a much better job of maximizing these tax exemptions and deductions.
However, some farmers who are self-employed may actually fare better under Scenario B than A since in two of the years they would pay no self-employment tax. Every farmer’s tax scorecard will be a little different and what works well for one does not work for another. Just like pro football teams that prefer the pass over the run, a farmer may prefer B over A or vice versus. 
Each farmer must run the tax “game-plan” to determine what works best for them during the regular season.


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