With 6 weeks to go before the end of the calendar year, time is fleeting for taking action on farm business issues that may have tax consequences. Year end tax planning is always important, but higher commodity prices and added income, your appointment with a tax advisor may be all that more important this year. Let’s take a look at some of the agenda items in that discussion.

Agricultural tax specialist Gary Hoff at the University of Illinois suggests numerous tax saving tools should be considered by you and your tax advisor. Many of the primary tools are included in his Year End Farm Tax Planning Considerations.

Income Averaging. Hoff says three years of income can be averaged. Crop share land owners can use the tool, which is also applicable to partnerships and s-corporations. With increased income your tax bracket may also change, but remember the upper and lower limits change yearly due to inflation adjustments.

Hoff says if your income from the past two years was under the upper limit of the tax bracket, some of your income from this year can be applied at those lower taxable brackets. Another tool is to file amended returns for the prior years, reduce the level of income in some of those years, and make more room in the bracket to accept money from 2007 taxed at the lesser rate. If you go the route of the amended return, it must be filed by April 15 or 2 years from the date the tax was paid. But Hoff says income averaging will not reduce the self-employment tax.

Self Employment Tax. To reduce self-employment tax liability in prior years, you may have deferred income to the next year; but Hoff says the higher incomes in 2007 may cause your Net Earnings from Self Employment to exceed the maximum amount subject to the 12.4% “retirement portion” of the Self Employment tax. He says it is capped at $97,500 in 2007 and $102,000 in 2008. Earnings above that are taxed at the lower Medicare rate. But Hoff says shifting grain sales into 2008 and pre-paying 2008 expenses could end up increasing your 2008 tax liability since it has been added to the 2008 Self Employment tax earnings.

Section 179 Expense Deductions. Machinery purchases, which fall under the Section 179 Expense Deduction, may provide a deduction up to $125,000. Hoff says the new or used equipment must be delivered and ready to use by the end of the year, and the full deduction can be taken if your farm income plus wages total $125,000 or more. If purchases exceed $500,000 then the deduction is reduced dollar for dollar above that threshold. The Section 179 tool also applies to farm buildings, grain storage, and breeding livestock, as long as it was not purchased from a relative. Keep in mind it can only be applied to the cash payment above the trade-in value.

Section 199 Deductions. You have come to know and love the Section 199 Domestic Production Activity Deduction, and for 2007 the deduction is now 6% of the qualified income, which Hoff says will be even more valuable. (For a thorough discussion of Section 199, either consult a tax advisor or see Hoff’s newsletter.)

Retirement planning. We are beyond the Oct. 1 deadline for establishing an IRA for 2007, however a Simplified Employee Pension account can be established by the tax filing deadline for yourself or employees. The maximum is 25% of the compensation, but no more than $45,000, but is keyed to the self employment tax for employers. For a self-employed farmer, a Keogh plan can be established by the end of the calendar year with a contribution that is calculated. A ROTH IRA is an individual plan with a $4,000 maximum annual contribution, or a $5,000 maximum for those over 50 years of age. Those contributions are not tax deductible, but earnings are tax free.

At Ohio State, Farm Management Specialist Don Breece provides several tax planning tips in his monthly newsletter.
1) Livestock sales forced by drought can receive favorable tax treatment. Breece says any gain on the sale does not have to be recognized if replacement livestock are purchased within 2 years. And a federal disaster declaration can extend that to 4 years.
2) Regarding disaster payments and crop insurance indemnity checks for yield loss, typically they are reported in the year they are received for the cash basis operation. Breece says an exception to the rule allows a 1 year postponement in reporting a crop loss payment.
3) Wages paid to children are a farm expense, but not subject to social security if the child is under 18. Since the standard $5350 deduction is not taxable, wages exceeding that amount will be taxed, but at a lower rate.
4) Deductions for prepaid supplies cannot exceed 50% of deductible farm expenses. Livestock producers cannot prepay this year for the feed that livestock will consume next year, unless the business purpose is not tax related and the deduction does not materially distort your income. Cash rents can only be deducted in the year they apply.

Since numerous Cornbelt farmers will receive indemnity payments for either drought, flood, or aflatoxin problems, the entire issue of tax treatment of crop insurance might be ripe for discussion. Minnesota Extension specialists Robert Holcomb and Gary Hachfeld advise in their newsletter that deferral of crop insurance payments are usually easily deferred for cash basis farmers. However, there will be several pitfalls to avoid.
1) The payment must be for the destruction or damage to a crop and the farmer must suffer an actual physical loss. That means that indemnity payments for GRP or GRIP insurance are not deferrable, since they are based on a county average, and must be declared in the year they are received.
2) The same applies to indemnity payments for crop insurance that is revenue-based, such as CRC or RA with the harvest price option. Payments for a price or revenue issue must be declared in the year they are received. Holcomb and Hachfeld advise against being creative and trying to break out the yield portion of the payment for deferral to next year.

Summary:
There is still time left to consult with a tax advisor and work on year end tax planning. While some prepayments might be made along with deferred grain sales, the higher levels of revenue that some farmers are reaching may need some different tax treatments such as income averaging. There are many other tools available to reduce tax liabilities, such as Section 179 expense deductions and Section 199 production deductions, as well as creating retirement accounts that may have tax benefits. Declarations of disaster and crop insurance indemnities can also be delayed if weather and physical loss related.