Bad years create tax planning opportunities
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EmailPlaying the long game in tax planning can minimize your overall tax liability.
When we think about tax planning, we usually think about reducing income taxes in a profitable year. However, many farmers are facing a loss on income taxes this year. Tax planning is still valuable in an unprofitable year. Maintaining a stable taxable income over time allows you to more effectively reduce the tax liability in future years.
Some losses may be able to be carried over to future years (or the past year), but often some of the benefit will be lost with that strategy. Negative self-employment income cannot be carried over, so that potential tax savings would be forfeited. There is an optional contribution to Social Security in a loss year, but that requires paying for the current year credits. In addition, the self-employed health insurance deduction requires positive net income for the business. Instead, the strategy of using tax planning to accomplish low (but positive) net farm income allows for the entirety of this year’s loss to be spread over future years and while maintaining these tax benefits.
The primary tools in year-end tax planning are income timing and decreasing cash expenses. The most common way to increase income is to sell farm products that may otherwise have been carried over to next year. Another opportunity to manage income is to recognize all insurance claim payments instead of deferring them. Deferring common bills, such as insurance premiums, rent or interest, until after the first of next year can also reduce the current year expenses. Since expenses are only recognized when a vendor is paid, you might also choose to buy inputs on vendor account. Another option is to reduce the amount of prepaid expenses for production inputs although you need to consider how this may offset the advantages of available discounts.
Taxable income can also be boosted to optimal levels for long-term planning by taking advantage of non-farm tax provisions. Although it does not impact self-employment income, a low-income year may also be an opportunity to convert Traditional IRA funds to a Roth IRA. If negative or extremely low self-employment income is unavoidable, you or your spouse may still want to pay into Social Security sufficiently to gain credits for social security.
Although year-end tax planning may seem like wasted effort in an unprofitable year, it is an important tool to reduce your long-term tax liability. Work with your tax preparer to develop a plan that is right for your farm. More information about farm income taxes can be found at the IRS website. Additional tax planning information is available from the MSU TelFarm Center. You can also contact your Michigan State University Extension Farm Business Management Educator with questions.
