Year-end Tax Planning

Dennis Ehrnwald, Farm Business Management Educator, Champaign County, (217) 333-7672, ehrnwald@uiuc.edu

Farmers are turning to the tasks of updating their record keeping, reviewing their cash flows, and considering pre-year end tax planning as well as organizing for tax filing. Pre-year-end tax planning is an important task. You can maximize your farm operation's profitability with effective tax planning. Coordinate your income tax planning with your cash flow planning and marketing. Verify that any tax planning meets your cash flow needs for your living expenses and debt repayment.

For example, the tax code permits you to purchase up to $20,000 of capital purchases and expense them rather than depreciate them. This strategy provides an immediate tax benefit. However, be certain that the new assets that you purchase are needed and are compatible with your cash flow planning. Some farmers have experienced a low farm income this year since their yields were lower. Their strategy could be to shift grain sales back to this year and delay some expenses until next year. This year's and next year's incomes can be more equalized which minimizes their chances of income tax bracket increase next year. Additionally, this strategy can be beneficial if they are paying storage, since storage costs are reduced.

Every year does not produce dramatic tax changes. However, most years do contain some tax changes. Changes can come from new Internal Revenue regulations or tax court rulings. This year has some tax changes. One example of a tax court ruling involves Conservation Reserve Payments (CRP). Before 1998, CRP payments were normally reported on Schedule F as a farm payment for those that were "materially participating" and were subject to self-employment tax. Those not "materially participating" in farming treated the payment as rent and not subject to self-employment tax. However, in the 1998 Wueber v. Commissioner case the tax court ruled that the CRP payments to those "materially participating" were not subject to self-employment tax. Thereafter, most "materially participating" farmers did not include CRP payments in their self-employment tax liability. Now an appeal of the Wueber case reversed the 1998 tax court ruling and includes CRP payments for those "materially participating."

Another example of tax change includes depreciation of property received in a like-kind exchange. The change effects property placed in service after January 2, 2000. Prior tax reporting used the basis of the traded property, added the new basis in the acquired property and depreciated the total over the life of the newly acquired property. The reporting change now requires a taxpayer to continue depreciating the remaining basis in the traded property over its remaining life using its same depreciation rate.

Any new basis in the acquired property is depreciated over the life of the acquired property at the permitted rate for that newly acquired property. You can see that income tax changes cause serious concern from year to year. Prudent coordination of tax planning and cash flow planning is important. Be sure to consult with your tax consultant to verify that you did not omit any strategy that could cause you financial harm.