Section 179 and bonus depreciation provisions are based upon a different set of dates for your asset purchases.  Bonus depreciation on new equipment is based upon the date that you actually purchase and place in service the asset.  For new assets bought between January 1, 2012 and December 31, 2012, you are entitled to use 50% bonus depreciation on these assets.  After December 31, 2012, bonus depreciation is no longer scheduled to occur.

Section 179, however, is based upon when your fiscal year begins.  For most individuals, you have a calendar fiscal year (there are some unique individuals that do not have a calendar year), but many entities such as corporations may have a fiscal year-end of any month in the year.

When you have fiscal year flow-through entities such as an S corporation, you must be careful to not pass through too much Section 179 to the individual.  For fiscal years beginning in 2011, the maximum Section 179 was $500,000.  For fiscal years beginning in 2012, this amount dropped to $139,000.  Therefore, if you have an S corporation whose year began in 2011 but ends in 2012, they may elect to take the full $500,000 and pass it through to their shareholders.  This may result in the shareholder getting a deduction greater than $139,000 and this excess is not deductible in 2012 on their personal return and the excess in almost all cases is completely lost.

For example, let’s assume Farm, Inc., an October 31, 2012 S corporation has two shareholders and passes through $250,000 of Section 179 to each.  The excess over $139,000, or $111,000 is not allowed and is most likely lost.

Usually the farmer is involved with the preparation of the return, however, in many cases, they are not.  If too much does get passed through to you, an amended tax return can be filed for the entity to reduce the Section 179 deduction.  However, other shareholders may need the deduction and this may create issues between the owners.

If you have fiscal year S corporations, make sure you know how this affects all shareholders before finalizing the return.  It may save you headaches later.

Paul Neiffer, CPA

Continuing our farm income averaging trend, we had a couple of readers ask if they could farm income average their cash rented ground.  The short answer is no.  In order to use farm income averaging, you must have “farm income” which is comprised primarily of the following items:

• Direct farm income from Schedule F,
• Flow-through farm income from partnerships and S corporations,
• Crop share income, regardless of whether the taxpayer materially participates, as long as there is a written agreement in place before the tenant begins significant activity on the land,
• Gains from the sale of farm personal property (sale of farmland is not included), and
• Wages a shareholder earns from an S corporation that is active in farming.

Cash rent income based upon a fixed rent are not allowed for farm income averaging.  The use of a flex rental arrangement may or may not allow the farmer to use farm income averaging depending on the terms of the lease.  Rents based on farm production (whether in cash or crop shares) qualify for farm income averaging, but many of the flexible rental arrangements that we have seen are usually a form of cash rent with an adjustment for market price changes, not production changes.  Therefore, these types of rent arrangements would probably not qualify for farm income averaing.

As you can see, this can get fairly complicated, but if the Bush Tax Cuts do expire, making a change to your form of farm rented ground in 2013 may save you some money.  As usual, review this with your tax advisor.

Paul Neiffer, CPA

We did a post a few days ago on how farmers may not be affected by the increased tax rates for 2013 if they use farm income averaging.  In that post, we used an example of spreading $1 million of farm income over four years, $250,000 in 2010-2013.  An observant reader reminded us that a farmer could spread even more income, if desired, to the period 2010-2012 to take advantage of the lower rates for those years.

Farm income averaging allows farmer to take an elected amount of income for any year and spread it over the prior three years.  They are limited only to the amount of farm income generated in the current year as long as this income is greater than their taxable income.

Therefore, even if a farmer in 2013 had a substantial amount of income for 2010-2013, they could elect to take their 2013 income and spread it over the prior three years.  As an example, lets assume a farmer had generated $1 million of taxable income for each year from 2010-2013 and all of this income was related to farming.  If they did not use farm income averaging for 2013, their federal tax would be about $358,000.  If the Bush tax cuts were extended into 2013, the net federal income tax would be about $318,000 or a $40,000 increase in taxes.

However, the farmer can elect to take up to $1 million of farm income and carry it back evenly to 2010-2012.  Since the farmer was taxed at a marginal rate of 35% in each of those years, they will elect to carry back about $777 thousand of 2013 farm income (the point when income is taxed at 36%).  This income is then taxed at 35% or about $272,000.  If it had not been carried back, the tax paid in 2013 on this income would be about $301,000 or a savings of almost $30,000.  The farmer cannot eliminate the whole $40,000 increase in taxes, but it is able to save about 75% of the increase.

If the farmer had very low income in 2010-2012, then most likely they could have avoided almost the whole increase in taxes.

Remember, even if the Bush tax cuts expire for 2013, if most of your income is from farming, you will be able to mitigate at least 75% or so of this increase by using farm income averaging.

Paul Neiffer, CPA

Since there is about one week to go in the year, we thought we would present a quick checklist for accounting and tax related items:

• Make sure that all checks for 2012 expenses are written and mailed by December 31
• Make sure that any gifts made at year-end are deposited into the donee’s account before year-end
• Make sure that all equipment bought before year-end is available for use.  Simply writing a check to the dealer does not make the equipment eligible for depreciation in 2012.  The equipment must be placed in service by December 31, 2012.
• Properly deposit all grain and other crop sale checks by year-end or denote in your accounting system as deposits-in-transit.  These items are income if you have constructive receipt by year-end.  Simply waiting to 2013 to deposit will not delay income recognition.
• Have your budget prepared for 2013.  If you wait until January to start, that is too late.
• Review your deferred payment contracts.  Do you have the right mix to allow you to increase your 2012 income if needed.  Remember, the Fiscal Cliff may happen, but it may be very late into 2013 before we know for sure.  Make sure you have income tax flexibility.
• Review your prior three year’s tax returns.  Have you used farm income averaging in the past.  With this year’s expected large increase in farm income, make sure you know if you qualify.  Also, for 2013, farm income averaging may get you out of any tax increases.
• If you have installment sales from prior years, have you reviewed electing out of them to lock in the lower rates now.  Certain steps must be taken before year-end.  Review those with your tax advisor.
• Have you reviewed your crop insurance reporting options.  You may need to perform certain steps before year-end.  Check with your tax advisor.

There are some of the major items that should be done before year-end.  If any apply to you, make sure you know what to do and it would not hurt to touch base with your tax advisor.  We would rather have you talk to us now that wait until January 2 when it might be too late.

Paul Neiffer, CPA

Just want to wish everyone a Merry Christmas over the next couple of days. We are still hanging on the fiscal cliff and most likely nothing major will be accomplished before year-end.

We will keep you posted, but for now Merry Christmas!

Paul Neiffer CPA

With all the talk about the possible higher tax rates starting next year we sometimes forget that farmers might not feel much of the hit due to farm income averaging. This special method of figuring tax allows you to average your tax over four years (2010-2013).

This means for 2013 you might be able to earn $1 million from farming and have most of it still subject to the old lower tax rates. This assumes you had no taxable income for 2010 to 2012. When this income is averaged over those years $250,000 would taxed using those tax rates for each year and for 2013 only $250,000 would be subject to those rates.

If they do keep the old rates for up to $250,000 the farmer has effectively had none of their $1 million subject to the new higher 39.4% rate.

This is a very unique situation, but in almost all cases a farmer will have less tax than other taxpayers due to farm income averaging.

I was talking with a reader from North Carolina today about our post from yesterday.  He was not sure if the annual exclusion amount was or was not included in the lifetime.  So, I have decided to do one more update on this subject. 

The first $13,000 ($14,000) of gifts that you give to everyone person each year are exempt for any gift taxation.  It is only when you go  above the this level, that you then start to eat into the lifetime exclusion. 

For example, if you give $12,000 of cash to Jim and $15,000 of cash to Jane, Jim’s gift is part of the annual exclusion and is not reported to the IRS at all.  Jane’s gift must be reported to the IRS on form 709 and the first $13,000 is exempt and the remaining $2,000 is then used to reduce the lifetime exclusion.  For 2012, assuming you had never made any gifts, your lifetime exclusion would drop from $5,120,000 to $5,118,000 after filing the gift tax return.

In brief, if you make gifts under $13,000, no reporting to IRS and no reduction in your lifetime exclusion.  For gifts over $13,000, only the amount over $13,000 is used to reduce your lifetime exclusion amount.

Remember that these rules are on a donee by donee basis.  So 10 gifts of $12,000 to 10 children/grandchildren/friends are both not reported to the IRS and do not reduce your lifetime exemption.

We had a reader ask the following question:

“Am I correct in that this accumulation of gifts during lifetime does not include those under the Annual Gift Tax Exclusion ($13,000)?”

It seems like most of my posts lately deal with estate and gift taxes, but this is a very important subject and with the end of the year less than two weeks away, we do not have much time to make major gifts.

As the question indicates, there  is both an annual gift exclusion amount and a lifetime exclusion amount.  These two items are mutually exclusive.  This means that any gifts  that fall under the annual exclusion amount will not reduce your lifetime exclusion totals. 

For example, in 2012, the annual exclusion is $13,000 which increases to $14,000 in 2013.  The  current lifetime is $5.12 million scheduled to drop back to $1 million on January 1.  If a married farmer has five children and ten grandchildren, he can give 15 gifts of $13,000 each to each child and grandchild or $195,000.  The wife can give the same amount.  This equals a gift of almost $400,000 in one year that still leaves their lifetime exclusion amount at the same balance. 

That is why we are able to transfer substantial amounts of land values to our heirs during lifetime by using appropriate discounts on LLC or LLP interests AND the annual exclusions.  In the above case, if the land was in an LLC and it was subject to a 35% discount, the farmer could gift $300,000 and his wife the same in gross land values and it still would not eat into his or her lifetime  exclusion.

Over time, the proper use of the annual gift exclusion amount can be extremely more valuable than the use of the lifetime exclusion amount.

Paul Neiffer, CPA

We have gotten a few questions lately on how the lifetime gift and estate tax exclusion are tied together.  In brief, transfers made during your lifetime are called gifts and reported on a gift tax return while transfers made at death are also a “gift”, but reported on an estate tax return.

The gifts made during lifetime are accumulated with the gifts made at death and totaled together.  If this total (lifetime and at death) exceeds your lifetime exclusion then either gift or estate tax is due.  For 2012, the combined exclusion amount is $5.12 million.  If you make $2 million of gifts during your life, no gift tax is due, however, if you are worth $4.12 million at death, the combined amount of $6.12 is $1 million greater than your lifetime exclusion and thus $350 thousand of estate tax is owed (2012 rates).

These rules apply for federal tax purposes.  Many states have an estate tax but no gift tax.  Gifts during lifetime may result in lower taxes than waiting until your estate.  However, some states that do not impose a gift tax will bring these gifts back into the estate and “tax” those amounts then.

There is some discussion on whether a “clawback” will occur if the current lifetime exclusion drops from $5.12 to $1 million beginning in 2013.  This “clawback” might occur if you make a large gift in 2012 and the lifetime exclusion in effect at that time of your estate is less than this gift.  Most commentators agree that this clawback will most likely not occur, however, nothing is certain right now with this issue.

Remember, even if a clawback occurs, substantial estate tax savings may result.  For example, if you gifted $5 million of farm land in 2012 and at the time of your estate the land is worth $10 million and the lifetime exclusion was $1 million, the maximum amount that would come back into your estate is only $5 million (the 2012 gift value), not the $10 million it was worth at the time of your estate.  In this case, you have completely eliminated the estate tax on the $5 million of appreciation created after your gift ($2.75 million of estate taxes eliminated) and if there is any clawback, the payment of it has been deferred for many years.

Conclusion – All gifts are added together, whether made during life or at death, and this total is what you may be taxed on.  The 2012 lifetime total not subject to gift and estate tax is $5.12 million.  It is not $5.12 million during life plus $5.12 million at death, but simply $5.12 million in total.  For 2013, this amount is scheduled to drop to $1 million, but Congress may change it soon.

Paul Neiffer, CPA

We have gotten some feedback on my previous post about revocable living trusts.  One of the features of a living trust versus a will is that the trust can be set up to provide for “guardianship” of your affairs during your lifetime should you suddenly become disabled, etc.

You can create other forms of documents that may accomplish the same, but by using the trust, you may be able to make this much easier on you and your family.

The primary intent of my post was to make sure that farmers understand that simply having a revocable living trust does not save estate taxes over what a properly drawn will would.  In many cases, setting up a revocable living trust makes a lot of sense, just do not expect it to generate large estate tax savings.

Generally the key to estate tax savings is the gifting of appreciating assets during your lifetime that will eliminate these assets being included in your estate.  A revocable living trust does not accomplish that.

As usual, please continue to send your comments and questions to the blog.  That is the best part of writing the blog.

Paul Neiffer, CPA