Tax planning is a valuable tool for reducing your tax liability
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EmailFarmers should consider adopting solid tax planning strategies that maintains consistent taxable income across multiple years.
One of the only certain things in farming is that the income tax deadline will come every year. Between federal and state income taxes and self-employment tax, prospects of a large tax bill can feel overwhelming. Year-end tax planning can address this concern and is an essential tool for farm financial management.
In general, the best tax planning strategy is to maintain consistent taxable income across years. This minimizes taxes owed over a longer span of years. Not only do tax brackets increase for higher income, but also many tax credits phase out at higher incomes.
There are usually three major strategies for tax management when net farm income is high – deferring income, prepaying expenses and taking accelerated depreciation.
- Deferring income commonly refers to carrying over crops or livestock for sale to the next year. Remember that income is recognized when funds are available to your farm, not when the check is cashed. A deferred sale is also effective as long as a contract states that payment will occur in the next year. In addition, some insurance claims can be deferred.
- Prepaying expenses not only increases cash expenses in this year but may also allow discounts on next year’s inputs. Remember that expenses can only be recognized when vendor is paid by cash, check or credit card. Purchases made “on account” with the vendor are not deductible.
- Taking accelerated depreciation refers to using section 179 and “bonus” depreciation methods. These depreciation options allow many asset purchases to be depreciated entirely or in large part for the current tax year. In high income years, farmers often want to heavily rely on accelerated depreciation to reduce taxable income. However, be cautious–while accelerated depreciation can significantly increase current year expenses, relying too heavily on it can leave you with a large tax liability on top of debt payments in future years.
Even after year-end, a few tools exist to further refine your tax liability. Contributions to personal IRAs and health savings accounts (HSAs) are not due until the April tax deadline. Depreciation decisions can also be made when preparing the tax return. In addition, farm income averaging is a tool that your tax preparer can use to reduce federal income tax.
Although year-end tax planning takes some effort, 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
