With January 16, 2012 being less than two weeks away, I thought I would update our farmers on their estimated tax requirement and give some examples.   As we have previously posted, most farmers work very hard to get their income taxes filed by March 1 of each year since as long as they file their return and pay any tax owed by that date, there is no penalty for not paying estimated taxes.

However, in many cases, I think it would be much better to pay in their required tax estimate on January 15 (this year January 16) and then pay the remaining amount owed on April 15.

The amount owed on January 16, 2012 is the lessor of (1) the 2010 total tax liability less any withholding already paid in for 2011, or (2) the 2011 estimated tax liability, net of any withholding, times 66.667%.

As an example, assume a farmer’s tax for 2010 was $10,000.  He had a very good year in 2011 and knows that his tax will be at least $100,000.  He can either pay this tax on March 1, 2012 or he can pay $10,000 on January 16 and pay the remaining amount on April 16, 2012 (the 15th is on a Sunday this year).  Let’s assume that he can borrow at 4%.

The interest cost on the $10,000 from January 16 to April 16 is about $100.  The interest cost on $100,000 paid on March 1 until April 16 is about $500.  Under this example, the farmer would be better off by about $400 by just making an estimated tax payment on January 16 and waiting till April 16 to pay the balance.  Also, he has an extra 45 days to prepare his tax return and make sure all of his form 1099s, etc. are correct.

Let’s take one more example of possibly the worst case.  Assume a farmer has to pay $100,000 of tax this year and his last year’s tax was well over that amount.  In this case, he needs to pay in $66,667 on January 16 and $33,333 on April 16 or pay $100,000 on March 1.  In this case, his interest cost on the $66,667 is $667 versus the $500 cost for paying the $100,000 on March 1.  He is out of pocket about $167, but he still got the extra 45 days to prepare the return.  Whoever prepares the books and the tax return would probably like to have the extra 45 days if the cost is only $167.

An alert reader let me know that one of my points on how to defer your crop insurance proceeds was not written as well as it could have been. 

In my original post, I had indicated that each crop is a “separate” business unit, then each crop is looked at separately.  This separate business unit definition is really based upon how the farmer accounts for his grain operations.  Almost all farmers account for their grain operation under one business unit which includes the production of corn, soybeans, wheat, cattle, etc.  Under these conditions, the farmer if they elect to do so, is required to defer all crop insurance proceeds for those crops that qualify for the deferral.  

Therefore, if the farmer has one business unit and crop insurance proceeds are received on both corn and beans, the eligibility test for deferring crop insurance proceeds is based on the aggregate. If together more than 50% of the crop sales are normally reported in the year after harvest, then the farmer can elect to defer all of the insurance proceeds to the following year.   

If the farmer, however, has more than one business unit with multiple crops, then each business unit can review its situation and decide if it wants to defer the crop insurance proceeds.  For example, a farmer may run his farm as a sole proprietor and have another farm operation with a brother in a partnership.  Both his crops and the partnership crops are damaged by hail and receive crop insurance proceeds.  The farmer can elect to defer his crop insurance proceeds, while the partnership can elect to not defer or vice versus.As you can see, crop insurance deferral rules can get a little bit complicated and each situation can be a little bit different.  Always review this with your tax advisor and thanks to the alert reader for requesting clarification.

We had a reader ask the following question:

“I was flooded on one farm & hailed on another so received multi-peril income this year. How much of our MPCI can be deferred?”

Without knowing all the facts here, we can give general advice on how much crop insurance proceeds can be deferred from one year to the next.  There are several rules that must be followed:

• The crop insurance must be for damage to the crop, not reimbursing you for a reduction in crop prices. 
• The general rule is that more than 50% of your crop sales normally occur in the following year.  For example, if you harvest corn in October, normally sell 35% at harvest and the remainder in the following year, you can defer your crop insurance proceeds.  However, if normally sell more than 50% of your crop at harvest or in the current crop year, you cannot defer the proceeds.
• First, the crop insurance proceeds must be received in the year of the actual crop damage.  If the crop was damaged in 2011 and the crop insurance proceeds were received in 2011, then you may defer the income to 2012 as long as you meet the other rules.  If the proceeds are received in 2012, you have already deferred the receipt by one year and thus it is taxable in 2012 and cannot be deferred to 2013.
• Each crop is a separate “business” unit, so each crop must be reviewed to see if the crop insurance deferral rules apply.  You may have one that qualifies and one that does not.  Therefore, if one crop (perhaps corn is sold more than 50% in the next year) and one crop (soybeans is sold more than 50% in the current year), then corn would qualify to be deferred and beans would not.
• You cannot pick and choose the amount that you can defer.  If you elect to defer the crop insurance proceeds, you must defer all proceeds received during the year for that particular crop.

These are the general rules and will cover almost all situations, however, there are usually some anomalies out there and you always need to review this with your income tax advisor.

President Obama signed late yesterday a new law extending the payroll tax cut for the first two months of 2012.  This means for January and February 2012, the employee’s portion of the FICA tax will be 4.2% instead of the normal 6.2%.  For self-employed farmers, for net SE farm income up to $18,350 shall be at the reduced rate (this is reduced by any other wages earned during the period).  If the payroll tax cut is not extended for the rest of the year, I am assuming the W-2 would have to be revised to reflect any wages earned between January 1, 2012 and February 29, 2012 (what a mess that would be).

However, the new law has a recapture provision for any wages earned during the first two months in excess of $18,350.  This recapture provision provides for a tax of 2% on all wages in excess of this amount earned during the first two months.  The $18,350 is one-sixth of the FICA wage base of $110,100 for 2012.

The IRS will interpret this new section including how this tax would be paid.  We will keep you posted.

We had a reader ask the following question:

“I put a deposit on a building in Nov 2011 thinking that it would completed and paid for by 12/31/11. The builder has not started the building yet and says it will most likely be completed mid January. What can i do to get the 100% cost deduction for 2012? Could I just pay for it now, or does it have to be 100% complete by 12/31/11?”

In order for a farmer to construct a new farm building in 2011 and be able to take 100% bonus depreciation on the building, it must be completed by December 31, 2011.  Usually having the occupancy permit that shows the completion date on or before that date will be sufficient, but in several states, the local county does not issue occupancy permits on many farm buildings.

In these cases, I would try to take photos of the property and get them date stamped and put in some type of file showing that the building was completed.  To prove the date, etc., you may want to hold up a copy of the local newspaper showing the date so that there is no question on what date the photo was actually taken.

In this case, since the construction will not be finished by year-end, then 50% bonus depreciation will apply in 2012, not 100% bonus depreciation in 2011.  There might be a chance that the construction is of two separate buildings.  For example, a machine shop may be one building and a shop located next to the machine shop may be a separate building.  If one is done in 2011, it would qualify for 100% bonus depreciation, but this does not appear to apply here.

Merry Christmas to all of our readers and we wish everyone a Happy New Year!

In my post yesterday, I need to clarify one tax aspect of the post.  When a farmer contributes all ordinary income assets such as unsold grain, farm equipment, etc. the deduction that the farmer may get is limited to his cost basis in the assets.  Since unsold grain for a cash basis taxpayer has a basis of zero and most farm equipment has been fully depreciated, there may be little or no tax deduction by creating the CRT.

However, the power of the CRT is the deferral of the income from the sale of the grain and the equipment, not the income tax deduction on creating it.

One additional nice feature of the CRT is that there is no self employment tax owed on the sale of the unsold grain for a schedule F farmer.  In many cases since there is little or no cost to offset against the grain when the farmer retires, this tax savings could easily exceed $20,000 or more in the year of sale.

Thanks to a reader for catching this for me.

We had a reader ask the following question:

“Is there any way to reinvest money from the sale of equipment(retirement) rather than pay ordinary income tax on it?”

Most farmers when they retire have a large amount of income from selling the final crop and their equipment and many times very little expenses to offset it with.  This results in a large amount income tax being owed, thus reducing the farmer’s after tax cash flow.

One method that we use to reduce and spread out this tax burden is the use of a charitable remainder trust (CRT).  The farmer will contribute their equipment and unsold grain inventory to the CRT.  Based upon the term of the trust, the farmer will get a tax deduction for this transfer.  The CRT will the sell the equipment and grain and owe no taxes on the sale.  Rather, this gain is accumulated and as the CRT makes payments to the farmer, they are taxed on the distributions when they receive the payments.  These distributions can be fixed at a certain annual amount or a percentage of the trust value each year.

In order to be a valid CRT, at least 10% of the assets transferred into the trust must be expected to go to charity at the end of the trust term.  A CRT is a great method to defer the tax for several years on the sale of farm equipment and final grain sales.

If this is something you are interested in, you need to review it with your tax advisor since there several calculations that must be made.

One example is as follows:

Farmer is retiring and has $1 million of farm equipment and $750,000 of final grain inventory to sell.  He does not need the cash immediately and wishes to use this as retirement income.  If the farmer sold the equipment and inventory for cash in his name, the total taxed owed would be about $750,000 assuming a top federal and state tax bracket.  He would have $1 million left over to reinvest at lets say 4% a year or $40,000.

By putting these assets in the CRT, it could sell the equipment and grain and pay no tax.  The CRT would have $1,750,000 earning 4% or $70,000 per year.  The CRT would then distribute this income and some principal out the farmer each year and it is likely that the farmer would be in a lower tax bracket on that income.

With the wrangling over the extension of the payroll tax between the House, Senate and President, we may not know if the payroll tax cut is in place on January 1, 2012 or not.  There is a chance that the extension of the law may occur early in 2012 and be retroactive to January 1, 2012.  We hope that this does not happen, but recent history shows there is a good chance of it occurring.

The primary issue for our farmers is whether the payroll tax software that they use is timely updated for these changes.  Right now, the law says there will be NO payroll tax cut in 2012, therefore, most of the software companies have programmed their software for this.  However, if a new law is passed either at the end of the this month or early next month, the software may not get updated for your first payroll.  This may cause it to be wrong and changes will need to be performed to get the right amount of pay to your employees and report the right taxes on your form 943 at year-end or form 941 for the first quarter.

We hope it does not get messy, but want to you warn you that it might.

We had a reader ask the following question:

“How do you prove what you paid for an land asset that is subject to capital gain purchased long ago if no records exist?  The land deed only shows the deed tax paid at the recorders office with no stated value.”

Although the requirement for keeping records in most cases is three full years, this is one of those situations where you always want to keep the closing statement on any land or property purchases until three years after the year of sale and I would highly suggest always keeping these records in your permanent file.

However, as in this case, many times these records are lost.

First, we must make sure that this property has not been inherited after the original purchase.  For example, if my father purchased 160 acres of land in 1960 for $50,000 and I inherited it in 2001, the new cost basis in that property is what it was worth on the date of my father’s death, not what he paid for it in 1960.  Therefore, if the reader had inherited this property, it does not matter what was paid for it.

Also, we need to verify that it was not partially inherited as in the case of a husband and wife, with one spouse inheriting the other interest, then 1/2 would be based on original cost and the other based on the value at the time of death (for a community property state, it would normally be like the first example on a full step-up in basis).

If neither of these circumstances apply, then we must try to find substantiation for what the original cost was.  In this case, I would try to track down who recorded the deed at the courthouse and if this is a title or escrow company or attorney, contact them and in many cases, they would have the original cost and closing statement.  Also, in some cases, the county will have a record of that sales information, it just would not be recorded on the deed.  If your state had an excise tax due on sale for that year, you may be able to get the information from the state or county.  Every state and county is different.

If none of this works, then we normally try to use our best judgment on what the original cost of the property might be and realize that if this return gets audited, that the cost may be disallowed.  Every case is different and you need to review with your tax advisor.

With most farmers net income for 2o11 being most likely higher than 2010, you may want to consider paying a tax estimate payment on January 17, 2012 to give you until April 15, 2012 to file your return.

Most farmers try to get their tax return filed by March 1 of each year.  If a farmer files and pays their income tax on or before March 1, there is no requirement to make any estimated tax payments for the year.  However, many farmers have invested in other operations such as an ethanol plant and many times they have to wait until after March 1 for the k-1 or the farmer has investments and the form 1099 does not even show up until after this date.

This causes the farmer and tax preparer to get in a huge hurry and many mistakes can happen.

If a farmer knows that his tax liability for 2011 will be higher than 2010, they can simply pay last year’s tax amount on or before January 17, 2012.  The required amount to be paid in is last year’s tax amount or 66.67% of this year’s tax (net of any federal income tax withholding including any overpayment applied from 2010), whichever amount is less.

With today’s low interest rates, paying in some tax on January 17th, with the remainder on April 15 will most likely have about the same interest cost of paying all of it on March 1 and save the farmer and their income tax preparer a lot of headache.

If you think this might apply to you, make sure to review your situation with your income tax advisor to determine what amount of tax to pay on January 17, 2012.