2. www.hbcpas.com
2
Agenda
• Depreciation
• Deferred Grain Contracts
• Prepaid Farm Expenses
• Taxation of Easements
• CRP and Self Employment Tax
• Federal Tax Estimates for Farmers
• Farm Income Averaging
3. www.hbcpas.com
3
Depreciation Update
• 50% Bonus Depreciation expired at
12/31/13 (new equipment)
• Sec. 179 limitation is currently at
$25,000 (new and used equipment)
– Reduced when property placed in service
exceeds $200,000
4. www.hbcpas.com
4
Depreciation Update
• U.S. House has passed a bill in June to
make permanent the $500,000 section 179
limit
• Senate not likely to vote until after
November election
• President has promised to veto the bill
5. www.hbcpas.com
5
How Do We Plan for This Uncertainty?
• Bill could be passed on January 1, 2015
and retroactively apply to 2014 year
• How do we make sure that income is
“low enough” if only $25,000 section 179,
but still allow for flexibility if section 179
limit is raised?
6. www.hbcpas.com
6
Tax Tip #1
• When selling grain in the current year for
next year payment, be sure to use
multiple contracts to allow income to be
“pulled” into the 2014 tax year if needed
7. www.hbcpas.com
7
Deferred Payment Grain Contracts
Background
• Sell grain in the fall (title has transferred)
• Wait to take check on January 1st
• Not income until the following year
• Installment sale contract
8. www.hbcpas.com
8
Deferred Payment Grain Contracts
Strategy
• Can elect out of installment sale
• Thus, contract by contract, a farmer may make
an election out of the deferred treatment
• Example: You have a $250,000 grain contract.
If section 179 is passed, then you offset the
increased depreciation expense with this grain
income.
9. www.hbcpas.com
9
Tax Tip #2 Amortizing Fertilizer
Expense
• If a higher Sect. 179 limit is passed:
– It may be beneficial to amortize the cost of
fertilizer paid for during the year, instead of
deducting it all in the current year
– Amount used each year would be deductible;
usually over 12 months, but may want to consult
an agronomist
– Works similar to deferred payment grain
contract
10. www.hbcpas.com
10
Prepaid Farm Expenses
• Definition: Items that are paid for in the year before
the year in which they are consumed or used
• Specifically includes:
– Feed, seed, fertilizer and other similar farm supplies
– Does NOT include rent or interest expense
– Spring-applied fertilizer and chemicals and seed paid
for in the prior year (paid for, but not yet applied)
11. www.hbcpas.com
11
Prepaid Farm Expenses Cont.
• Generally deductible in the year of payment for
cash basis taxpayers (including partnerships
and S corps) if three tests are met:
– Test 1: Payment must be for actual purchase (i.e.
enforceable sale contract)
• Specific quantities of specific item(s)
• No right to refund
• Should not substitute for different items
12. www.hbcpas.com
12
Prepaid Farm Expenses Cont.
– Test 2: Needs to be for a business
purpose and not merely for tax avoidance
• Discount/fixing maximum price
• Securing adequate supply
– Test 3: Deduction will not result in a
material distortion of income
• Quantity purchased should be comparable to
quantity used in the next year
• Customary business practice
13. www.hbcpas.com
13
Prepaid Farm Expenses Cont.
• Limited to 50% of deductible non-prepaid
farm expenses unless:
– Due to change in business operation
– Due to extraordinary circumstances
– Prepaid farm expenses for last three years total
less than 50% of deductible non-prepaid farm
expenses for last three years
14. www.hbcpas.com
14
Prepaid Farm Expenses Cont.
• Example:
– Total farm expenses, including
depreciation on Sch F, of $1 million
– $600,000 represents deductible non-
prepaid items, such as depreciation,
chemicals, fertilizer, interest, etc.
– $400,000 represents prepaid chemicals,
fertilizer and seed to be applied next year
15. www.hbcpas.com
15
Prepaid Farm Expenses Cont.
• Is any of the $400,000 limited?
– Non-prepaid expenses are $600,000
– 50% of $600,000 is $300,000
– Therefore, prepaid expenses of $400,000 are limited
to only $300,000
– $100,000 carried over to next year
– Limit is NOT 50% of $1 million
– Note: May be able to avoid limit if under
50% limit for prior three years
16. www.hbcpas.com
16
Prepaid Farm Expenses Cont.
• Example of prior three years test:
Prepaid Non-prepaid
Prior Year 1 $275,000 $625,000
Prior Year 2 $300,000 $650,000
Prior Year 3 $325,000 $675,000
Total $900,000 $1,950,000
(46% of non-prepaid)
Since prepaid expenses total less than 50% of non-
prepaid expenses for the prior three years, the current
year 50% limit does not apply.
17. www.hbcpas.com
17
Taxation of Easements
• Payments for easements can produce:
– Reductions to basis in land
– Long-term or short-term capital gains
– Ordinary income
• Usually have all of the above on the
same transaction
• Can be eligible for like-kind exchange
18. www.hbcpas.com
18
Taxation of Easements Cont.
• Perpetual easement with significant
rights retained, such as the ability to
farm the ground:
– Basis in land affected by the easement is
first reduced to $0 by proceeds
– Any additional proceeds are treated as
gain reported on Form 4797 (usually L/T
capital gain)
19. www.hbcpas.com
19
Taxation of Easements Cont.
• Perpetual easement with no rights
retained is treated as a sale of the
underlying affected land
– Essentially the same treatment as when
rights are retained
– It is possible for a loss to be recognized if
basis in affected land is greater than
proceeds
20. www.hbcpas.com
20
Taxation of Easements Cont.
• Easements that are of specific duration
(or not perpetual) run the risk of being
treated as ordinary (lease) income by IRS
• Temporary easements are rental income
• Crop damage payments are generally
ordinary income
21. www.hbcpas.com
21
Taxation of Easements Cont.
• It is possible to reduce the entire basis
of property by damage proceeds if the
entire property is affected by the
easement (severance damages)
– Example: power lines across the middle of
property that was designed for
development
22. www.hbcpas.com
22
CRP SE Tax Update
• Before 2003, IRS stated that if taxpayer materially
participated in a farming operation, CRP payments were
subject to self employment tax
• In 2003, IRS took the position that merely signing the CRP
contract resulted in the taxpayer being engaged in the trade
or business of farming
• In 2008, Congress precluded CRP payments from SE tax for
taxpayers receiving Social Security retirement or disability
benefits
23. www.hbcpas.com
23
CRP SE Tax Update Cont.
• In 2013, U.S. Tax Court case decided in favor of
IRS in assessing SE tax on CRP payments on land
inherited by an out-of-state landlord
– If taxpayer cash rented the land, no SE tax
would apply
– Ignored prior court cases that stated the
existence of a trade or business is determined
by facts and circumstances
– Note that active farmers will generally
automatically be subject to SE tax
24. www.hbcpas.com
24
CRP SE Tax Update Cont.
• Eight Circuit Court of Appeals heard oral
arguments in June 2014, so stay tuned
25. www.hbcpas.com
25
Cash Basis Accounting
• Can you pay expenses this fall and – if
later income is found to be too low – just
postpone the deduction until 2015?
• Not really…
26. www.hbcpas.com
26
Cash Basis Accounting
• Generally for all other deductions, the
deduction must be taken when payment
occurs
• Arbitrarily postponing expenses is not
allowed
27. www.hbcpas.com
27
Cash Basis Accounting
• Cash Basis Exception #1:
− You can begin depreciating equipment
when you legally own the asset and it is
available for use, regardless of when
payment occurs
29. www.hbcpas.com
29
Fed Tax Estimates for Farmers
• March 1st deadline for filing and paying
tax
− Can be difficult to have all K-1s ready and file the
return by March 1st
− Solution?
− Pay a January 15th tax estimate
− Pay tax on April 15th and incur interest charge
30. www.hbcpas.com
30
Fed Tax Estimates for Farmers
• Be aware you are only charged interest from
January 15th to April 15th, if you elect to pay late
• Federal interest rates are generally very low,
although they are nondeductible
• Interest figured on the smaller of:
− 100% of prior year tax or
− 67% of current year tax
31. www.hbcpas.com
31
Fed Tax Estimates for Farmers
• Current Year Tax x 67% x 90/365 x 3%
• $100 in tax owed = $.50 penalty (one-half of one
percent)
• About a 2% annual interest rate (keep in mind,
nondeductible though)
• $100,000 in tax owed = $500 interest charge
32. www.hbcpas.com
32
Farm Income Averaging
• All net farm income is eligible for farm
income averaging, even if the taxpayer
does not qualify as a farmer for the
March 1st filing date
33. www.hbcpas.com
33
Farm Income Averaging
• Income that qualifies for farm income
averaging besides Sch F net income:
– Gain on sale of equipment or breeding stock (Form
4797)
– Wages to a shareholder from an S corporation
engaged in farming
– Pass through income from farming from partnerships
and S corporations
– Crop share income, provided there is a written
agreement entered into before tenant begins
significant activities
34. www.hbcpas.com
34
Farm Income Averaging
• Income that does NOT qualify for farm
income averaging:
– Farm income passed through from a trust
– Gain from the sale of land
35. www.hbcpas.com
35
Farm Income Averaging
• Allows a farmer to take current year
income, which is being taxed at higher
rates, and instead tax that income at the
rates in effect for the prior three years
• With rates being increased starting in
2013, make sure this is being computed
36. www.hbcpas.com
36
Farm Income Averaging
• Farm income averaging:
– $150,000 of farm income in 2014
– Take $150,000 / 3 = $50,000
– The $50,000 is then taxed at the marginal rate in
effect for
– 2013
– 2012
– 2011
37. www.hbcpas.com
37
Farm Income Averaging
• The income on which self-employment
tax is computed is based upon the
current years income and does NOT get
averaged
– In the prior example, SE tax would be based
upon the $150,000 ($150,000 x 92.35% x
15.3% = $21,194)