There is a provision in the Income Tax Code that disallows certain farm losses that are in excess of $300,000 (or the aggregate farm income for the last 5 years).  This excess amount is not allowed in the current year, but is carried forward and allowed as a deduction in the next tax year (assuming you still meet the requirement in that year).

This provision only applies if the farmer is receiving any direct or counter cyclical payments under Title I of the 2008 Farm Bill (as extended last year).  The proposed 2013 farm bills by both the Senate and Congress eliminates these payments, so there is a strong chance that after passage of this farm bill and full implementation that this provision will no longer apply.

We have seen several of our clients that were unable to fully deduct their current farm loss even though they had received less than $5,000 in direct payments.  The farmer does not lose this deduction, but simply carries it forward.

Also, with the drought last year, any expenses that are a direct result of the drought are not included in the calculations for this limitation.

We will keep you posted if this provision no longer applies.

Paul Neiffer, CPA

At the Northwest Ag Bankers conference yesterday Corey Brock a local attorney spoke on various issues related to estate and tax planning for farmers.

In most parts of the Columbia Basin water project a farmer is limited to owning 960 acres. If you go over this limit certain penalties will apply including possible loss of water to the excess land which can quickly destroy the value of the land. Current values for irrigated land might approach $12,000 while non-irrigated land might only fetch $500.

In his case, grandparents had set up a trust calling for land to be distributed to their heirs at a certain point in time. One of the heirs already owned 960 acres so any additional acres distributed to them would cause this penalty to apply. They are working to resolve the issue, but the point is that care must be taken to make sure that any estate documents created such as a trust is designed and reviewed for local Ag laws and rules.

Without this review nasty non-tax costs can arise.

I was talking with a new farm client the other day about his estate plan and what struck me the most was not how much farm land value he had accumulated but rather the amount he had tucked away into his retirement plans. This amount was over 6 figures and he had only been contributing for a little more than a decade.

His annual contributions were in the $50,000 range and with a little bit of compounding a tidy sum can result. One of the benefits that arises is the flexibility in your estate planning. This can be a good vehicle to fund charitable intents at death or can be used to help equalize values between farm and non-farm heirs. One drawback is that these funds are subject to income tax when the heirs withdraw them.

We see too many farmers that are land rich and cash poor and with some some care these pension contributions can  save you income taxes and make you more liquid.

Paul Neiffer, CPA

Almost fully back from the rigors of Tax Season, it is now time to start posting on our more usual basis.  We got the following question from one of our readers in response to our post on using deferred payment contracts.

“What about the 1099 that you would receive from the elevator that would show the income in the year the cash was received, not the year the crop was actually sold?”

As Congress and the IRS adds more and more items of income requiring form 1099s, it will not be to far in future where all of page 1 of Schedule F will be a reconciling schedule requiring farmers to list all of their income from each type of form 1099 and then provide an explanation of how their actual income from those items would be different.  We are not there yet, but I predict it may not be too many years in the future.

For today, a farmer in this situation would make sure to list the gross amount of income from the form 1099 in the appropriate box on schedule F and then provide an adjustment on the other income line.  This adjustment can be negative.

For example, assume a farmer sells all of her corn to the local cooperative for $1,000,000 for 2012 with $800,000 in cash received in 2012 and $200,000 received in 2013 on a deferred payment contract.  She elects to report all $1,000,000 in 2012 and lets assume she has no other crop sales in 2013.  The Coop will issue a 2013 form 1099 to her showing $200,000 of sales (assuming they show it as per unit retains).  She will report this $200,000 on the appropriate line and then report a negative $200,000 in the other income box.  Since this section will now show a negative number, we would normally attach a schedule letting the IRS know that this represents an adjustment for electing out of the installment sales on certain 2012 sales or similar wording.

Some practitioners may elect to report the $200,000 on a gross basis and then report the taxable amount as zero.  We find that reporting it this way can lead to more letters from the IRS, but either way would result in the correct amount of income reporting.

Paul Neiffer, CPA

In our post yesterday on the deferred payment contracts, we had indicated that there were six different combinations of income that could be reported using the three contracts shown.  A couple of very observant readers had indicated we had missed one.  The one missed was that all three contracts could be reported in 2013.  Therefore, to recap the amounts that could be reported as follows:

• $50,000
• $60,000
• $70,000
• $110,000
• $120,000
• $130,000
• $180,000

These are the seven different amounts of income that could be reported.  For example, if you wanted to increase your income by $150,000, you would have to decide between $130,000 and $180,000.  You would not be able to pick exactly $150,000.

Many thanks to the observant readers out there for catching this.

Paul Neiffer, CPA

We seem to get several questions during tax season regarding how deferred payment contracts work for tax purposes.  I thought we would do another post on the mechanics and show some examples.

With a deferred payment contract, the farmer has sold their grain, but elected to defer receipt of the payment until a future date, usually the next year.  Since the farmer is using the cash method of accounting, the income is usually reported when they receive the cash.  However, this transaction is technically an installment sale and one of the elections a farmer can make is to “elect” out of the installment method and report the sale when the transaction occurs, not when the cash is received.

This is a very simply election.  Simply report the sale on your return and you are done.  No statement is attached and no other indication to the IRS is required.  The key thing is to remember not to report the income when you collect the cash the next year.

This election is on a “contract by contract” basis.  It is an all or none election for each contract.

For example, lets assume we have a farmer that has sold 30,000 bushels of corn in 2012 using three deferred payment contracts with collection to occur in 2013.  Contract # 1 is for $50,000. Contract # 2 is for $60,000 and Contract # # is for $70,000.  Under is normal method of accounting, he would report these three contracts in 2013 for $180,000.  However, he has six alternatives available for the 2012 tax year.  He can elect to report either Contract #1, 2 or 3.  He can report 1 and 2, 1 and 3 or 2 and 3.  This allows him to report in 2012 the following amounts of income:

• $50,000
• $60,000
• $70,000
• $110,000
• $120,000
• $130,000

These are the only 6 options available to him.  He cannot report half of contract # 1, 2, or 3, but is limited to reporting one 0f these six options.  That is why we suggest having multiple deferred payment contracts and having a couple of small ones to allow the greatest flexibility.

On a personal note, we made it through another tax season.  I think today is my first day off in over 2 months and I am going to go hit the little white ball (or at least try) and wear shorts for the first time all year.

 Paul Neiffer

It seems like it was only three months ago that we had a new law making the lifetime estate tax exemption $5.0 million indexed to inflation ($5.25 million in 2013).  Wait! It was only three months ago.

President Obama today release a 2014 budget proposal calling for changes to this “permanent” law.  Beginning in 2018, the budget would return the estate tax laws back to 2009 levels.  This would result in a $3.5 million lifetime exemption (not indexed for inflation) and a 40% tax rate.  This may also include the elimination of estate exemption portability since that was not in effect in 2009.

Based on assumed 3% inflation rate, we estimate that the current lifetime exemption would increase to $6 million in 2018.  If the President’s proposal goes into effect, about $2.5 million of additional estate value would be subject to a 40% estate tax.

The proposal also calls for certain “loopholes” to be closed.  Most likely these relate to discounts for private entity gifts and estate values and other related items (these “loopholes” are always in these types of budget proposals, but rarely get passed).

On the direct farming side, the President’s proposal, as expected, calls for the elimination of direct payments (saving about $3.3 billion per year ) and a reduction in crop insurance premium subsidies by about $500 million in 2014 rising to slightly more than $1.25 billion a couples years thereafter.

Paul Neiffer, CPA

One of our last posts indicated that the IRS had issued a notice indicating they might not assess the late payment penalty for returns that are extended and paid after April 15, 2013 if the return included certain forms that were delayed by the new tax law.

However, when you read the fine print, it appears that you still need to accurately estimate your tax and pay in at least 90% of this extra tax to escape the penalty.

In addition, if you are farmer who delayed their filing until after March 1, 2013 to avoid paying your taxes until April 15, 2013, remember that the underpayment penalty will now kick in if you wait until after April 15 to pay.  This now means that your interest rate will be the current 3% rate plus the underpayment rate of 3% plus if you are hit with the late payment penalty, that is another .5% per month or an annualized rate of 6%.

If you add all of these rates together, you now get a total annualized interest rate of 12% (again none of it is deductible).  We would suggest paying your tax by April 15 unless you really are certain you can earn more than 12% after-tax on your funds.

Paul Neiffer, CPA

There are officially two weeks until April 15 to get your taxes filed (unless you elect an extension).  If you have not filed yet, here is a check list of things to do between now and then:

• Fully fund IRAs for you and your spouse.
• Fund your retirement plan (KEOGH, SEP, SIMPLE).  Even if you have not set one up, there is time for some types of retirement plans to be created and funded by April 15 or October 15 if you do an extension.
• Unlike prior years, you have a decision on whether you wish to pay in any amounts due with your extension.  In past years, this would cost you the regular annual interest rate (currently 3%) plus .5% for each month that you are late.  This late penalty is based on being one day late in a month so if you pay on the first day of the month, the IRS could assess the full .5% penalty.  However, this year due to the delays in getting the forms released, the IRS will not charge this penalty.  They will charge interest.  If your borrowing costs are greater than 3%, you may want to consider taking advantage of this, however, the interest is non-deductible.
• Review your farm income averaging options.  Even if this does not save money for you this year, it may save money in 2013-15.
• Make sure to determine if any state or federal credits apply to your tax situation.  In many cases, these credits can easily add up to real money and we find that many times they are overlooked.  In some states, if you are unable to use the credits, you may be able to sell them to others that can use them.

This is a quick check list for the last two weeks of tax season.  The delay in the release of the tax forms has caused this tax season to bunch up even more than normal.  We will be preparing many returns between now and April 15 and if yours is one of them, make sure to get is filed timely.

Paul Neiffer, CPA

About 20 years ago Congress passed a law that still provides confusion to both taxpayers and many members of the media.  Many people thought the new law outlawed IRA contributions if you were covered by a retirement plan at work.  Assuming you have sufficient compensation or self-employment earnings, the law simply disallowed the deduction if you were covered by a retirement plan AND your adjusted gross income was over a certain threshold.

The law never eliminated the ability to make an IRA contribution. 

In general, the rules are as follows (assumes you and your spouse have at least combined earnings of $10-12,000 or more (if over age 49):

• Not covered by a retirement plan – Both spouses can deduct up to $5,000 (in 2012, increases to $5,500 in 2013) plus if age 50 or over, you can each contribute another $1,000 for a total of $6,000 each. 
• If both are covered by a retirement plan, you can still deduct a full IRA until your combined adjusted gross income hits $92,000.  At this point, the deduction is reduced 50 cents for each dollar increase.  Once you hit $112,000, no more deduction (the numbers for single are $58,000-$68,000).
• One covered by retirement plan, one not.  The non-covered spouse can deduct a full IRA until the couple’s adjusted gross income hits $173,000 and is fully phased out at $183,000.

The ROTH IRA makes it a little more confusing.  You can only contribute up to $5,000 ($6,000 if 50 and over) between a regular IRA and a ROTH IRA.  This can be allocated in any manner you want, but the combined amount cannot exceed the limit.  However, ROTH IRA’s are reduced once your adjusted gross income hits $173,000 and is fully disallowed at $183,000 (same limits for one non-active spouse).  The single limits start at $110,000 and is fully phased out at $125,000.

Remember, an IRA or ROTH IRA contribution for 2012 tax returns must be fully funded by April 15, 2013.  This applies even if you get an extension of time to file, it does not extend the IRA due date.

Also, if you file early in the year and get a nice size refund from the IRS, you can use that refund to fund your IRA.  There is no requirement to have the money in the IRA before you file your return.  You can even have part of your refund automatically deposited into your IRA by the IRS.

We have roughly 19 days of tax season left and we know they will be hectic for all of us.  Spring planting is just around the corner for our farmers, while us CPA’s are finishing up our “harvest”.

Paul Neiffer, CPA