As farmers approach retirement, extra income taxes may be owed on the built-up grain holdings that they sell in their final year of farming without offsetting deductions. These deductions are incurred in the year of harvest while the grain sales usually occur in the year after harvest.
One option to help reduce this tax is the use of a retirement plan such as a 401k. However, these types of plans have a limit on the amount of deduction and for 2022 this limit is $64,500 including the over 50 catch-up provision.
If a farmer would like to deduct more than that, then a cash balance plan may make sense. This type of plan allows a farmer to deduct a much larger amount perhaps $200,000 or more. However, it normaly requires the farmer to make the deduction for at least five years and will result in much higher sefl-employment or payroll taxes. Also, any current employees of the farm will need to be covered and require annual contributions.
Let’s look at an example:
Assume Mary has $1 million of excess grain that she has built over the last many years of farming. Starting five years before her retirement, she could set up a cash balance plan, sell an extra $200,000 of grain each year and have an offsetting cash balance plan deduction to offset the grain sales. The extra cost would be the SE tax or payroll taxes plus the fees to administer the plan.
Note, that starting at age 72, Mary would have to start taking her required minimum distributions and hopefully pay tax at a lower rate.
The cash balance plan does not eliminate the tax but rather pushes the income into future years and spreads it out over many years at usually lower rates.
If you are interested in this type of plan, make sure to review it was an expert in this field. These types of plans are more complicated than a normal profit-sharing or 401k plan.
