By JEFF BURBRINK
Extension Educator Purdue Extension
GOSHEN — A wise person once told me to concentrate on what you can change, because worrying about things you cannot is a waste of time and energy. One thing that individuals cannot do much about are the low commodity prices we are experiencing. The market has a glut of milk, corn, beans and other commodities, and we cannot change that.
Between now and the end of the year, you may have some control over how your 2016 federal income tax turns out. Of course, every farmer’s tax situation is different, but once Jan. 1 is here, your options are limited. Tax planning is just as important in low income years as it is in high income years.
Tina Barrett, who is the director of Nebraska Farm Business Inc., wrote a story about end of the year options farmers should talk to their tax accountant about. One suggestion: is important that Schedule F losses are avoided if possible. A loss on Schedule F typically means that income could have been recognized free from self-employment taxes. Since the self-employment tax amounts to 15.3 percent, it is something that should be managed whenever possible.
The easiest things to do is sell more grain/livestock or reduce expenses. Sometimes there are management reasons why these things shouldn’t be done by Dec. 31. Companies may be offering discounts for early prepay or the market is going to have enough volatility that the grain is held until after the first of the year. There are a couple of things to think about before those decisions are made.
Barrett also noted that another way to generate taxable income without losing control of the crop is to use commodity loans. More information about these loans can be found here.
A commodity loan allows an operator to take a low interest loan for the amount of the loan rate on harvested bushels. These loans can be elected to be treated as income on your tax return. So for the price of some paperwork and patience, income can be brought into a loss year and the operator would still be able to sell the crop when the marketing opportunities arise.
Barrett said one other way to generate taxable income is to elect out of an installment sale agreement or what is commonly known as a deferred price contract. A true deferred price contract will be written with the language that the contract is an installment agreement where the producer agrees to receive payment at a later date (often right after the first of the year). The election out of the agreement from a tax standpoint is done by simply recognizing the income in the year the agreement was made instead of when payment is received. This creates some record-keeping issues so it’s important to keep good track of what is done so that the income isn’t taxed.
If a negative Schedule F cannot be avoided, Barrett said it is important to try to avoid having a Net Operating Loss. These are overall losses on the tax return. Sometimes if farm income can’t be generated, other non-farm income can be generated and recognized free from income taxes.
For example, over the past few years of profitability, many producers have used tax-deductible IRAs to defer income taxes. If there is going to be an NOL on the tax return, an individual could consider rolling traditional IRAs into Roth IRAs. The transaction would generate taxable income on the tax return, but the earnings would be 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.
In a similar way, Barrett suggested if non-farm investments such as mutual funds or stocks owned outside of an IRA have increased in value, those could be sold and either reinvested in other stocks or right back into the same investments to establish a new basis. The gain would be recognized in the same year as the farm losses, again resulting in no tax on the gain.
Barrett pointed out that one could save some tax dollars in the long run by selling equipment outright instead of trading it for new. A trade results in a like-kind exchange that is a tax deferral strategy. If the old piece of equipment is sold outright, the gain is recognized in the current year as ordinary income subject to income taxes. This would offset farm losses. The purchase of the new asset can be depreciated and will hopefully provide a larger deduction for both income and self-employment taxes in the future when profit returns.
All of these strategies are dependent on specific issues related to your operation and tax return. These topics should be discussed with your tax professional before incorporating them into your operation.