It’s nearing the end of the year, and that means time is running out to make educated business decisions that minimize your income tax liabilities.
Tax planning is important every year – it’s been an extremely volatile process the past few years with significant fluctuations in commodity pricing and all of the government aid that farmers have received. This year is no different! 2021 offers a few wrinkles to consider with existing and potential tax law changes; however, many steps in the tax planning process remain unchanged.
Your financial records must be in order, accurate, and up to date!
Help your tax accountant help you. At the very least, you need a computer accounting program or worksheet that reconciles bank and loan statements to account for cash in and out of your operation. If you don’t have this completed, assign it to a member of your operation or contract with a professional. It’s always best to stay on top of it on a monthly basis – the past few years, maybe more than ever, have shown the importance of being able to produce accurate records at the drop of a hat. Not only is it extremely helpful in making educated business decisions, but many times it’s been a requirement to take part in and meet mad dashes for COVID-19 government aid initiatives.
Keep it up
Putting your accounting records off until the end of the year makes it tough on everyone. Effective tax planning is not easy and in order for a tax accountant to do a good job for you, they need good information. If you haven’t started yet, develop a plan to get caught up. Set up a schedule to keep yourself on track. The goal is less stress and better outcomes!
Make informed decisions
Sometimes farmers make decisions they shouldn’t because they are following what they did last year. Considering buying the same amount of prepaids or making a capital expenditure because you had to last year? This year may be markedly different than last year. Good financial records help in making these decisions.
Everything is important
For example, you might not think an equipment purchase was important because you haven’t made a payment yet, but your tax preparer needs to know about it. It’s also easy to let things that happened early in the year slip your mind by the end of the year, so keep excellent records.
Meet with your accountant before the end of the year to discuss your financial situation and what tax bracket you’re going to be in. With enough time, you may be able to bring in additional income if you’re facing a net loss, or you make a purchase if your income is too high.
Frequent tax planning strategies
There are a variety of ways to decrease and increase taxable income that can be used year in and year out. Not all of them may be applicable given your operation’s circumstances but are important for you to have on your radar.
Methods to decrease taxable income
- Farm income: Averaging all or some of your farm income using rates from the three prior years.
- Common expenditures to reduce taxable income: Prepaying inputs and other allowed items, capital expenditures, and retirement contributions.
- Depending on your entity structure, retirement plan contributions can be significant, especially for self-employed individuals via a SEP, simple or other qualified plan. This also establishes retirement assets outside of the farming operations. Diversification is a good thing!
- Healthcare deductions: Create an employee benefits deduction to allow for business deduction of these expenses.
- Selling under a deferred contract: You can sell grain before the end of the year, but not be paid until after the first of the next year. You then have flexibility to decide, after the fact, if you need additional income in the year that the crop was sold. Make sure you sell in several small contracts rather than one large contract to provide more flexibility for when to show income. Also, consider the risk of collection in your decision-making process.
Methods to increase taxable income
- Election to capitalize repairs rather than expensing them: It can be adjusted annually.
- Maximizing depreciation methods, including direct and bonus expenses: Try to never depreciate your way out of standard deductions and exemptions.
- If a farm loss is inevitable, common ways to increase income include: IRA distributions, IRA to Roth IRA conversions, and sale of non-farm capital assets (i.e., stocks). An IRA to Roth IRA conversion generates taxable income on the tax return, but the earnings are tax free. Any farm losses may be offset by the income generated from the rollover and no income taxes would be owed on the money rolled into the IRAs.
2021 tax changes to think about
Advance Child Tax Credits: If you have qualifying children under 18, and did not opt out of receiving monthly payments, by now you have received months of advance payments in 2021. These payments will impact your net tax position when you file your 2021 tax return. Keep good records of the payments you’ve received and give it to your tax accountant! More details on this topic can be found in the article, Advance Child Tax Credits on our website, www.greenstonefcs.com.
Payroll Protection Program (“PPP”) proceeds are tax free: This goes into the bucket of “everything is important”. Make sure your tax accountant knows where you recorded this in your records. If not communicated, these amounts could be erroneously included in taxable income or as a reduction of expense on your income tax return. Overcommunicate!
Potential changes in tax rules under Biden’s American Families Plan (AFP) proposal: President Biden’s AFP proposal outlines tax law changes – predominantly focusing on individuals that earn more than $400,000 annually. The proposal includes higher tax rates for ordinary income, higher tax rates for capital gains, elimination of tax-free-like-kind exchange gains exceeding $500,000, and numerous other items. The AFP has not been passed and as of the date of this article we’re not aware of when Congress may vote on the plan. Keep watch for updates and discuss the potential impact with your tax accountant.
Farmer March 1 tax deadline – buy yourself some time by making an estimated tax payment!
Many farmers have the understanding that their income tax returns are due by March 1 each year. While that is one of the deadlines, it doesn’t have to be the case for all farmers. Read our article titled “Why you may want to plan to not file your taxes by March 1 each year” on our website, www.greenstonefcs.com, to learn how to buy yourself until at least April 15, maybe even October 15, to file your return by simply making an estimated tax payment by January 15. Ask your tax accountant when your return is actually due and if making an estimated payment is an option for you. We’re finding this option more and more helpful to farmers given all the tax complexities and the timing of receipt of year end forms.
Paying some tax is actually a good thing!
You’re probably cringing reading that line – but it’s true. Paying tax means you’re making money, which should be the goal of running a successful farming operation. Paying federal income tax builds up your future Social Security / disability earning potential. You should always manage to maximize the 10% and 12% effective tax rate brackets. Try to avoid taking out loans simply to buy equipment to avoid taxes. You save taxes in year one, but you have the loan payment for years to come, which can cause you to continue to feel cash poor.
An ever-changing 2021
Every operation needs special attention, especially in more-complicated years. Our tax accountants at GreenStone Farm Credit Services realize this, and we’re ready to work with you on your individual needs. Please don’t hesitate to contact us - it’s never too early to plan for taxes.
To view the article in the online 2021 Fall Partners Magazine, click here.