Larimer & Boulder Counties, Colorado 2008 December 17 th

Larimer & Boulder Counties, Colorado2008 December 17th

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• Agricultural and Business Management Economist– Ranch raised– Colorado State University

Extension Department of Agricultural & Resource Economics

– [email protected]– www.coopext.colostate.edu/tranel

• I am not a Certified Public Accountant

Jeff Tranel

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Income Taxes

• Congress alters tax code periodically• Tax Court rules on tax issues

• Can often be

interpreted in multiple ways

• Income tax codes and

regulations are complex.

Please consult with your tax practitioner about

application of tax codes and regulations.

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What Are Your Goals?

1. To make money Short term? Long term?

2. Taxes No taxes? Minimize taxes? Pay more taxes every year?

3. Equity (net worth) Maintain? Increase?

“A farmer will never go broke paying taxes”

- Anonymous Farmer

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Your Goals

ExxonMobilAfter tax income

= $22.6 billion

ExxonMobilTaxes =

$61.7 million

Definition of a Farm

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For Profit Farming

• It is a business if there is net income or profit in three of last five years

• Activities consisting of breeding, showing or raising horses, it is a business if there is a profit in

two of last seven years

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Intent to Profit

• Farming for profit– Operate in business like manner– Time and effort – Depend on farming for livelihood– Losses due to circumstances beyond your control– Change operation in attempt to increase profitability– Have necessary knowledge– Past success– Profits earned in some years– Expect profits in future years

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Hobby Farming

• Definition– Profit is not primary motive– Farm income not primary

source of income

• Tax Implications– Limit on deductions– Cannot use loss to offset

income from other activities– Report income on Form 1040

and deduct expenses on Schedule A (Form 1040)

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Qualified Farmer?

• 2/3 of Gross Income – must come from farming/ranching

in current or prior year

• Gross Income = All Income

• Farm Income= Income from Farming/Ranching

(Schedule F)

+ Gross Farm Rental Income (Form 4835)

+ Gross Farm Income(Schedule E, Parts II & III)

+ Gains from Sale of Breeding Animals (Form 4797)

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Material Participation

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1. Regularly and frequently makes, or takes an important part in making, management decisions.

2. Works 100 hours or more spread over a period of 5 weeks or more.

3. Does things that, considered in their

totality, show material and significant

involvement.

4. Does any three of the following:a. Pays half

b. Furnishes

c. Advises or consults

d. Inspects

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• Income and deductions from farm rentals, including government payments received by the landowner, are subject to self employment (SE) tax, if:– Sell, exchange, give away, or

use the crop shares– Materially participate at the time

the crops are produced

Importance of Records

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• Meet the needs of:– You– Lender– Tax preparer– Other

• Are required by the IRS to be

kept for 3 years after date of filing – 7 years in cases of suspected fraud– Applicable years regarding capital assets

Records

Farm Income

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• Sales of livestock and other items purchased for resale – Sales of farm products purchased for resale– Profit or loss is the difference between the basis in the item,

usually the cost, and any payments received – Basis may have been carried forward from a previous year

• Sales of livestock, produce, grains, and other products raised– Sales of all raised products

Farm Income

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Agricultural Program Payments– All agricultural program payments, including CRP payments

Even if a government check was returned for cancellation or the government collects all or part of the payments by reducing the amount of another payment or CCC loan

– The government should send the taxpayer a Form 1099-G indicating the total amounts received

Crop Insurance Proceeds– Proceeds from insurance on growing crops

Included in gross income in the year actually or constructively received.

Farm Income

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Crop Insurance Proceeds– Proceeds from insurance on growing crops

Included in year actually or constructively received

– Can be postponed until following year if: Use cash method of accounting Received insurance proceeds in same tax year as crops

damaged Normal business practice to sell crop in following year

Farm Income

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Farm Income

Other Income– Items that generate income during the year.

Crop share rents Breeding fees Sales of soil Items not included in other sections of farm income.

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CRP Payments

• Before– If actively farming, active income (Sch. F)– If not actively farming, passive income (Sch. E)

• Now– By complying with terms of CRP contract, you are actively

farming CRP payments are considered “government payments” not

rental payments

• After 2007– If receiving Social Security benefits (retirement or disability)

CRP payments are excluded from self-employment income

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Hedging as Risk Management

• Hedging transactions entered into in normal course of business

• For risk management purposes

• As forward contracts, futures contracts, options

• Commodity is produced on the farm or directly affects the business

• Generally an ordinary gain or loss

• Reported on Schedule F

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Hedging as Speculation

• Hedging transactions entered into which are not part of the ordinary business of farm

• Has specific record keeping requirements

• Reported on Form 1040

Farm Expenses

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Farm Expenses

• Ordinary and necessary costs of operating a farm or agricultural enterprise.

• Capital improvements increase basis of applicable assets.

• Depreciation reduces basis.

• Expenditures for purchases of items for resale are not deductible in year occurred (under cash method).

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Car & Light Truck Expenses

• Must be able to prove deduction for travel with adequate records or other evidence.– Example: account book supported by things such as expense

receipts

• Not deductible for commuting miles• Depreciation limited (if placed in service in 2007)

– $3,060 in 1st year– $4,900 in 2nd year– $2,850 in 3rd year– $1,775 in 4th and later years

• $25,000 max depreciation-for SUVs

See Publication 946.

Assumes 100% business use.

Limits are higher for light trucks, vans , and electric vehicles.

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Car and Light Truck Expenses

• Up to 75%– Directly in connection with farming– In first year the vehicle is placed in service– Cannot change to another method at later

time

• 100%– Must have records of proof– Must be used for business the percentage

that is claimed

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Car and Light Truck Mileage

• Standard mileage rate– $0.505 in 2008 (Jan 1 – Jun 30)– $0.585 in 2008 (Jul 1 – Dec 31)

– Business miles only– Not deductible for commuting

miles– Cannot be used if operating 5+

cars and light trucks at the same time

– Business rate in 2009 = $0.55

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Prepaid Livestock Feed

• Deduct the cost of livestock feed to be consumed in a later year if (meet all tests)

• Deductions for prepaid livestock feed may be limited to 50% of other deductible farm expenses

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1. Payment is for the purchase of feed rather than a deposit• Specific quantity• Fixed price• Not entitled to refund or repurchase

• Would be considered a deposit if: Absence of specific quantity terms Right of refund of any unapplied

payment credit Right to substitute other goods or products If there is a provision in a binding contract permitting

substitution of ingredients to vary particular feed mix to meet livestock’s current diet requirements will not suggest a deposit


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2. Prepayment has a business purpose and is not merely for tax avoidance.• Reasonable expectation of receiving

some business benefit for prepayment• Examples

Fixing maximum prices Securing assured feed supply Securing preferential treatment

in anticipation of a feed shortage


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3. Does not materially distort income.– Customary business practice– Expense in relation to past purchases– Expense in relation to income

for the year– Time of year


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Summary for deduction of prepaid livestock feed:

• Payment is for feed, not a deposit

• Payment has business purpose,

not for tax avoidance

• Prepayment does not

materially distort income


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Wages for Labor

• Deduct reasonable wages

• Use fair market value of any assets given to hired labor

• Deduct as farm expenses the costs of boarding farm employees

• Issue Form W-2 for all employees

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Contract vs. Employee Labor

• Entered as “custom hire”

• Cost must be capitalized

• “20 Factors”

• Individual contractors receiving more than $600 must receive a Form 1099-MISC

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Hired Labor- Family Members

• Deduct reasonable wages and other compensation paid your child

• Deduct reasonable wages and other compensation paid your spouse

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Prepaid Farm Supplies

• Amounts paid during the tax year for feed, seed, fertilizer, and similar farm supplies

• Must use cash method of accounting

• Limited to 50% of other deductible farm expenses

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Exceptions to the 50% Limit:

• Does not apply to farm-related taxpayers if:– Business operations changed due

to unusual circumstances– Total prepaid farm supplies in

preceding 3 years is less than 50% of total other deductible farm expenses in those three years

Prepaid Farm Supplies

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Business Use of Home

• Can deduct expenses for business use of home if part of the home is used exclusively and regularly

• Deduction limit applies

• Any depreciation taken reduces the home’s basis

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Business Use of Home - Telephones

• Cannot deduct cost of basic local telephone service for the first telephone line into the home

• Can deduct:– Business long-distance changes on the first line– Cost of second telephone line into the home if used exclusively

for farm business

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Depreciation

• Annual deduction recognizing that assets wear out or become obsolete

• Types of tangible property

• To be depreciable, property must meet conditions

• Records of depreciation on capital assets must be kept by the taxpayer

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Depreciation

• To be depreciable, property must (meet all tests):– Be owned– Used in the business or income producing activity– Have a determinable useful life– Be expected to last more than one year

• Most types of tangible property.– Buildings– Machinery & equipment– Vehicles– Livestock– Fences– NOT land

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Depreciation

Recovery Period in Years

GDS ADS

Single purpose ag structure 10 15

Single purpose horticulture building 10 15

Farm buildings 20 25

Farm machinery and equipment 7 10

Ag fences 7 10

Truck (13,000 lbs or more) 5 6

Water wells 15 20

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Depreciation

Recovery Period in Years

GDS ADS

Cattle (dairy and breeding) 5 7

Goats and Sheep (breeding) 5 5

Horses (age when placed in service)

Breeding & Working (12 years or less)

Breeding & Working (more than 12 years)

7

3

10

10

Hogs (breeding) 3 3

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Depreciation – Breeding Livestock

• Raised breeding livestock:– Not typically depreciated– Incurred expenses deducted as ordinary farm expenses– Have no basis when sold

Sale price less selling costs equal capital gains

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Depreciation Limits

• Limits– Passenger automobiles of < 6,000 lbs (GVW)– Entertainment and recreational property– Computers– Cellular telephones– Generally, most assets that lend themselves to personal use

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Depreciation – Section 179

• Allows deducting all or part of qualifying property in the year “placed in service”

• Qualifying property

• Property must be used more than 50% for qualified business use

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Depreciation - Section 179

• Allows deducting all or part of qualifying property in the year “placed in service”.

• Qualifying property:– Purchased for business use

– Personal property, ag fences

– Single purpose ag structures

– Does not include real property

• Property must be used more than 50% for qualified business use.• Limits in 2008

– Apply to individuals

– $250,000 for married couples filing jointly (MFJ)

– Reduced as total cost of all qualifying section 179 property placed in service within the tax year exceeds $800,000

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Depreciation – Example 1

$125,000 Adjusted purchase price for machine

- 0 Section 179 Allowance

125,000 Depreciable basis

/ 7 Years of recovery

= 17,557 Depreciation using SL method

X 50% Calculation for half-year convention

= $8,929 Depreciation for 1st year (year placed in service)

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Depreciation – Example 2

$125,000 Adjusted purchase price for machine

- 100,000 Section 179 Allowance

25,000 Depreciable basis

/ 7 Years of recovery

= 3,571 Depreciation using SL method

X 50% Calculation for half-year convention

= $1,786 Depreciation for 1st year (year placed in service)

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2003 2004 2005 2006 2007 2008 Total

Loan Payments

Interest 870

662

447

227

2,206

Principal 7,182

7,390

7,604

7,825

30,000

Example 1: Using MACRS Depreciation

Depreciation

4,500 7,650 5,355

4,998

4,998

2,499

30,000

Tax savings

1,679 3,178 2,244

2,031

1,949

932

12,013

Revenue needed 7,773 9,262

9,602

9,733

36,370

Multi-Year Effects of Depreciation Decisions

Strategies for Managing Tax Liability

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Tax Management Goals

• It may not be best to minimize taxes

• Should maximize after tax income across multiple years

• Matching depreciation deductions to loan payments

• May not “show up” on financial statements

• Tax management decisions in one year can affect cash flow and financial viability of a firm in future years

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Tax Management Goals

• Match depreciation deductions

to loan payments

• Manage taxes and financial

risk over multiple years

• May want to take bigger

deductions up front to keep

out of a higher tax bracket

• Deferred taxes may not catch

up to the farmer until retirement

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Defer Tax Payments

• Tax minimizing strategies only defer (delay) income tax payments

• Many farmers report crop revenue in one year and expenses on another year’s tax return

• Large tax consequences may result at a time when financial hardship already exists

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Reducing Profits – Gross Income

• Postpone receipt of revenues

• Reduce revenues from livestock and crop sales

• Reduce non-livestock/crop revenues

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Reducing Profits – Expenses

• Prepay supplies• Prepay feed• Increase expenses• Increase depreciation• Pay higher than necessary

prices• Use extraordinary amounts of

items• Pay consultants

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Increase Taxable Income

• Reasons why someone might want to increase taxable income:

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Self Employment Taxes

Rate = 15.3%– Social Security = 12.4% (max earnings = $102,000)

– Medicare = 2.9% (max earnings = unlimited)

Net Farm Income + Other SE Income

X 92.35%

= Net Earnings From SE

X 15.3%

= Self-employment TaxesIf net earnings from self-employment

is less than $400, there is no SE Tax liability.

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SE Taxes – 4-H/FFA

• Sales of 4-H and FFA projects are generally not subject to SE taxes

– Project must be primarily for educational purposes

– Project completed by the individual under rules and economic restrictions of the sponsoring 4-H or FFA organization

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Standard Deductions & Exemptions

2008• Standard Deductions (under 65)

– $ 5,450 Filing Single– $10,900 Married Filing Jointly– $ 8,000 Head of Household

• Personal Exemptions– $ 3,500 per dependent– Phased out as adjusted gross income certain level

Tax Rate Schedule (MFJ) - 2008

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Income Range Income Tax

More Than Less than Amount Plus Percent times Amount Over

--- 16,050 --- 10% 0

16,050 65,100 1,605 15% 16,050

65,100 131,450 8,963 25% 65,100

131,450 200,300 25,550 28% 131,450

200,300 357,700 44,828 33% 200,300

357,700 --- 96,770 35% 357,700

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Retirement Accounts

• Traditional IRAs – Adjustments to gross

income– Taxed when withdrawn– Required distribution (70 ½)– Contribution limits, generally

$5,000 in 2008 $6,000 (if 50+)

• Roth IRAs– Taxed in year of investment– No required distribution– Contribution limits, generally

$5,000 in 2008 $6,000 in 2008 (if 50+)

• SIMPLE, SEP-IRA, Keogh, Other

• Publication 590

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Estimated Taxes

• Farmers not required to make estimated payments.– Qualified farmer– File tax return and pay all taxes by March 1st

• Qualified farmer can make a single estimated payment by January 15th

– Then has until April 15th to file tax return and pay balance of taxes owed

• Making estimated payments– Must, if above to not apply– May

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More Information

• See your tax preparer

• Visit the IRS– Telephone– Website (www.irs.gov)– Publications and Forms

Publication 225 (farmers tax guide)

Larimer & Boulder Counties, Colorado 2008 December 17 th

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Transcript of Larimer & Boulder Counties, Colorado 2008 December 17 th