I have received multiple e-mails in the last month or so about the Obama 3.8% sales tax on the sale of your home starting in 2013. 

There is no federal sales tax on any home sale in today’s tax law.

However, there is a provision in the Health Care Act passed earlier in the year that will assess an extra 3.8% surtax on investment income starting in 2013 including capital gains.  This surtax applies if a farmers adjusted gross income is greater than $200,000 or $250,000 if married.  This is an extra income tax on capital gains, not a sales tax.

Let’s compare the effect of this tax compared to a sales tax.

Let’s assume a farmer has a house that they have owned for many years.  They paid $50,000 for it 30 years ago and it is now worth $500,000.  Under current income tax law, the gain on sale of this house is completely tax free.  A sales tax of 3.8%, if it applied, would cost the farmer $19,000.

Now lets assume the house is not the farmer’s personal residence and they sell it for a $450,000 gain in 2013 and their other income is over $250,000.   In this case, their capital gain of $450,000 would be subject to an additional surtax of 3.8% or $17,100 which would almost be equal to a sales tax but not quite. 

The only time the surtax is equal to a sales tax is if the cost basis is exactly zero.

One other Internet based e-mail that I have seen several times is that we are now required to report our health insurance premiums paid for our benefit on our W-2 at year-end as taxable income.  The e-mail will site the health care act as the requirement, however, they mis-intepret the actual wording of the law.  What is actually required is that the premiums do need to be reported on form W-2, however, not as income.  It will be reported in a separate box similar to other reporting that is already being done on the W-2 for other non-taxable items.

I know some farmers probably feel that CPA do not have any humor, but I think we enjoy jokes about our profession a lot.   So, in that spirit, I am listing some humor below.

Trick or Treat

The doorbell rings, and a farmer answers it.  Here stands this plain, but well dressed kid, saying “Trick or treat?”.

The mans asks what the kid is dressed up as for Halloween.

The kid replies, “I’m an IRS agent.”

Then the kid takes 35% of the farmer’s candy, leaves and doesn’t say thank you.

Ashes to Taxes

A farmer on his deathbed called his frient and said “I want you to promise me that when I die you will have my remains cremated.”

His friend asked, “And what do you want me to do with your ashes?”

The man said “Just put them in an envelope and mail them to the IRS.  Write on the envelope ‘Now you have everything.’”

Income Tax Law

All the Congress, all the CPAs, all the tax lawyers, and a convention of wizards can not tell for sure what the income tax law says.

The Oldest Profession

A surgeon, CPA and a lawyer were arguing about which of them was practicing the oldest profession.

The surgeon said “God created Eve from a rib from Adam.  Obvisiouly, God is a surgeon, so medicine is the oldest profession.”

The CPA protested, “Before God created Eve from Adam’s rib, he created an orderly universe from chaos.  That clearly shows that God was an accountant before he was a surgeon.  Accounting then has to be the oldest profession.

The lawyer sat for a moment smiling, looking at the surgeon and the CPA.  “That may be true,” the lawyer said shrugging his shoulders, “but who created the chaos?”

The recent deadly floods in Pakistanhave destroy $3.27 billion of rice, cotton and sugar production according to is Farm Minster Naza Muhammad Gondal.  The country lost about 2.4 million metric tons of rice (about 80 million bushels) and 10.4 million metric tons of sugar can.   The country may also need to import almost 3 million bales of cotton which would be a 1 million bale increase from last year. 

The cotton loss is one of the primary reasons why cotton prices have gone of $1 per pound and have reached a 15 year high.

Over 2,400 miles of roads have been destroyed and food inflation for the current year may exceed 20%.

Rice exports may plunge up to 35 percent for the year reaching no more than 3 million tons from last year 4.6 million tons.

About 15 percent of the sugar crop was destroyed and the county may need to import a million tons of raw or refined sugar to meet demand.

It seems almost anywhere we look in the world weather problems are raising the price of food.  It will be interesting to see if the trend continues or if things get more back to “normal”.

The IRS has released the fifth annual list (published each September) of counties or parishes in which exceptional, extreme, or severe drought has been reported during the preceding 12 months.  This list can be used instead of the U.S. Drought Monitor maps to determine whether an extended replacement period applies for livestock sold because of drought.

If a rancher sells livestock due to drought, the rancher is allowed a certain number of years to replace this livestock with new livestock and report no gain from the sale.  This period is normally four (4) years, however, if the county where the ranch is located is still subject to drought during the three years preceding this four year term, then the time to replace the livestock is extended until the county has been drought free for a year.  The first drought-free year is the first twelve month period that :

• ends on August 31
• ends in or after the last year of the taxpayer’s 4 year replacement period; and
• does not include any weekly period for which exceptional, extreme, or severe drought is reported for any location in the applicable region.

In brief, the rancher is allowed a full year after the county is completely drought free before the rancher is required to purchase their livestock to replace the herd sold.  In some cases, the rancher may have five or ten years to replace the stock if the county has extreme drought for at least one week in each year during this time period.

The rancher can either look at the Drought Map to determine whether this applies or just review the IRS notice that is prepared each September. 

If this situation applies to you, check with your tax professional to see how much time you have to replace your livestock without incurring a tax penalty.

A very observant reader spotted an error in my last post on the new tax goodies.  In the reporting section for real estate rentals, the form 1099 reporting is for services provided to the real estate investor for items such as repairs, accounting, etc.  The payer of the rents was already required to report this information.

I enjoyed getting your feedback and appreciate bringing to my attention any errors that I write from time to time.

The Small Business Jobs Act of 2010 was just recently passed by both the House and Senate and President Obama will sign it when he gets back from China.  This Act has several tax “goodies” for farmers and it also has some not so good “goodies”.  A recap is as follows:

Section 179 Expensing  - Earlier in the year, the law increased the expense deduction up to a maximum of $250,000. This Act increases that amount to $500,000 and the phaseout does not start until you purchase at least $2 million of equipment.  For almost all farmers, these numbers will be more than enough.  This provision applies to any tax years that begin in 2010 and 2011.  Therefore, for this year and next, a farmer could purchase up to $1 million in equipment and deduct the whole amount.  Again, the income limitations of Section 179 apply and remember to not buy equipment just for the tax deduction.

Bonus Depreciation- The 50% bonus depreciation has been extended to December 31, 2010.   This means that any equipment will qualify for immediate 50% deduction and the remainder will be depreciated using current methods.  Most single purpose agricultural facilities will also qualify.

First year Auto Deduction – Depreciation deductions for autos and light trucks have been increased by $8,000.  Therefore, instead of the current deduction levels of about $3,000, you can now write off $11,000 in the first year.

Five-Year Carryback of Small Business Unused General Business Credits- Many farmers have accumulated general business credits that they may not have been able to offset against income tax due to the alternative minimum tax (AMT) or other reasons.  The new Act allows these credits to now completely offset the AMT and if there are any excess credits, they can be carried back five years instead of the current one year.  A small business is defined as revenues of less than $50 million so this provision should apply to almost all farmers.

Reduced Recognition Period for S Corp Built In Gains – Previously, if you converted from a C corp to an S corp and you sold in property with in a 10 year period that had a built in gain, you were required to pay an extra tax on these gains.  For tax years beginning in 2011, this period has been shortened to five years for all of the S corps who have been changed for at least five years.  Therefore, if you converted to an S corporation on or before January 1, 2006, you no longer have to worry about the built-in gains tax at all.  If you converted after that date, you are still subject to the 10 year rule.

Deduction of Health Insurance Against Self-Employment Taxes – This provision will apply for almost all self-employed farmers.  Currently, you could deduct your health insurance premiums for your family against other income, but could not deduct it against your self-employment taxes.  For 2010 only, you can now deduct these costs against your self-employment income.  This could easily save up to a $1,000 in self employment tax for many farm families.

Cell Phones Are No Longer Listed Property- Under the current law, cell phones and other similar telecommunication devices were considered listed property which means that a taxpayer needed to keep a log of their business use of these devices and back out the personal use on their income tax return.  I am sure all of our farmers were following this rule closely.  However, beginning with this year, you no longer need to keep track of this use and a cell phone paid for by the business should be 100% deductible.  Now if the business is paying for all minor children’s cell phones, that would probably still not be deductible.

These are the tax goodies.  What are the “baddies”?

Information Reporting for Servcies Provided to Rental Investors- Beginning in 2011, you will now be required to file a form 1099 for all services provided to real estate rental investors paid in excess of $600 for the year.  This means you will need to get the name, address and identification number from all of your service providers for repairs, accountants, etc. and report those payments beginning in early 2012.

Increase Penalties For Not Filing Information Returns – Beginning with 2011, if you fail to file any information return timely, the penalty for this failure to file increases dramatically.  There are three different tiers of penalties related to the type of information return such as 1099, W-2, etc.  In summary these penalties will increase as follows:

• Tier 1 – From $15 to $30 per return, maximum from $25,000 to $75,000 per calendar year;
• Tier 2 – From $30 to $60 per return, maximum from $50,000 to $200,000 per calendar year;
• Tier 1 – From $50 to $100 per return, maximum from $100,000 to $500,000 per calendar year.

These penalties can be dramatic, however, the IRS has some leeway in waiving the penalty for reasonable cause, etc.  For example, assume you are a large orchard operation that hires up to a 1,000 workers to pick your fruit, etc.  If you fail to timely file your W-2 for the year, the penalty for this failure could be $100,000 or more.  With the other new rule passed earlier in the year for filing form 1099 for all transactions exceeding $600, any failure to file these returns can cost a farm easily $25,000 to $100,000 or more.  Start getting your record keeping system updated now.

As you can see from the recap of provisions, there are more substantial tax “goodies” than “baddies”.  As long as you properly report your information returns, the benefit from this Act far outweighs the cost.

Any farmers who are having a good year and need to upgrade their equipment, this is the year to take advantage of the expanded Section 179 provisions or purchase the maximum amount by the end of this year and another $500,000 in 2011 and you will be able to write all of the equipment cost off.  With a combine at $300,000 or more, it does not take too much new equipment to get you to the $500,000 ceiling.

When farm commodity prices are increasing, the coverage of Ag tends increase by the Wall Street press.  In today’s Wall Street Journal, there were two articles related to Ag commodities.

In the Ahead of the Tape article, there was a discussion on how the price of cotton going over $1 per pound for only the second time since the Civil War will affect apparel retailers.  The article mentioned that for every penny increase in cotton prices, Hanesbrands, Inc. would have their raw material costs go up by $3 million.  Now, the interesting thing to me, is when cotton is at 50 cents a pound, you would never see the Wall Street Journal having a front section article on how a 1 penny decrease would save $3 million.

On page 2 of the Money and Investing Section was a featured article on how a timely rain in Russia is helping Black Earth Farming Ltd. get their entire 44,000 acres of winter wheat planted in Russia.  The gist of the article is that rains have come to Russia to save the crop, however, when you read the article in detail, there are still many sections of Russia that have not gotten any or much rain and their winter wheat crop will only cover 15 million hectares (about 37 million acres) at best.

When prices are low, you almost never see any articles on Ag commodities in the Wall Street Journal, however, when prices are high, you tend to see lots of them.  I am hoping to see a lot more.

Please note that the Wall Street Journal site is a paid subscription site, so you may not have full access to the article without being a subscriber.

A reader asked me for any books that I would recommend regarding farm taxes.  As a CPA, there are several courses around the US that I can attend to get my continuing education and these courses do provide workbooks for us as CPAs.  However, they are not designed for reading by a farmer since they are more in a outline format.

I have researched this on the Internet and have found a couple of small booklets on the subject that I think can help farmers.  You do need to make sure that these resources are updated each year since the tax law does change and lately, it changes rapidly.  Two that I find helpful are:

1. University of Minnesota Extension has a “Ag Income Tax Update for Farm Families“.  This gives a good overview of farm taxation including some Minnesota specific data.
2. North Dakota Extension Service has a good guide on tax records retention labeled “What to Keep Where and For How Long”
3. Washington State University prepared a “Federal Income Tax Management for Farmers and Ranchers” guide back in October, 1995.  Although this is outdated, the actual guide has very good income tax planning principles that will not get outdated.
4. Another slightly outdated manual was prepared by Purdue University titled “Income Tax Management for Farmers in 2008“.

Finally, the old standby is Publication 225 from the IRS – “Farmer’s Tax Guide”.  This is a very comprehensive outline of farm taxation from the IRS standpoint.  It does a great job of explaining the tax law, but you will not find any tax planning or strategies in this guide, but you need to be able to use it.

There are a couple of out of print books that you may be able to find on Amazon or the net.  The  first book is “Farm Estate and Business Planning” by Neil Harl, long-time instructor at Iowa State University.  I have the 1994 version in my library and I think the last time it was updated was 2001.  As the title indicates, this is primarily a book on tax and estate planning for farm families and does a great job on that subject.  You will not find much current income tax planning in this book.

Another book is Ag Executive’s Tax Guide for Farmers and Ranchers by Davenport and Dunteman.   This book was published in 1993, so a lot of the material is outdated, but a lot of planning topics are still pertinent.

Some of the paid marketing services such as Pro Farmer, DTN, and others have several income tax related sections and most of these are quite good and are updated at least annually.

My personal goal assuming I find the time is to come up with my own “Farmers Tax Guide” and post it on my site and keep it updated at least annually.  With the personal extensions almost done, this will give me about 3 months to get it done before tax season.

I spent this weekend and Monday traveling to Boise from Yakima and back again.  On the trip down to Boise, I drove through the irrigation section of the Columbia Basin.  This area grows a wide variety of crops such as onions, potatoes, wheat, corn, peas, beans, hay and lots of vegetable seed crops.  After that, I drove through Southeastern Oregon with its range land for cattle.

As I was driving into Idado, I noticed sugar beets, a lot of dairy, corn, wheat, and other related corps.  I spent some of my time on Monday driving around the Treasure Valley of western Idaho.  There is quite a bit of fruit trees and vineyards in this area along with the row crops.

On Monday, I drove north through the Payette River and Salmon River valley.  If you have never made this trip, you must go on it.  This is some of the best scenery in the US.  I met with  a farmer near Lewiston that grows twelve different crops.  From Lewiston, I drove home through the Palouse Country and again back through the Columbia Basin.

After putting on 1,100 miles, I can tell you that just the Northwest part of the country grows a bountiful range of crops and I am proud to be part of American Agriculture.

As corn starts to exceed $5 in price and pricing can be locked in 2011 or even 2012 crops, have you checked your budgets for those years.  If you have and are able to lock in your major input prices such as fertilizer and diesel, you should be looking at making $250 per acre or more on corn.  This is some of the highest profits in the last 10 years.  In order to accomplish this now by hedging your corn price, you must be able to also hedge your input prices.

I have listened to several marketing experts on ways to accomplish this and I think several of them have merit.  Therefore, make sure to review your budgets for these years and at least consider locking in both revenue and costs numbers for 50% or more of your corn and bean and wheat crop.  We do not get opportunities like this too often, so make sure to take advantage of this.

I would welcome comment on what steps our farmers have taken to lock in input prices.