Taxes

Taxes

TaxesAg ManagementChapter 9

The Purpose of Income Tax Management Farmers and ranchers are not tax exemptKnowledge and awareness of tax regulations can assist in decision making processes

A Manager & TaxesNot expertsBasic knowledge is helpfulMost popular publication for farmers and ranchers is Publication 225Can be obtained from any tax office

Special Laws for SpecializationBecause agriculture includes many specialized areas, tax laws for agriculture are also specialized

3 Examples of Special Tax LawsSpecial accounting methods despite high year-end inventoriesSpecial capital expenditure deductionsTreatment of livestock as a capital asset is unique.

Those That Can Tax Advantage of Special Tax LawMust be a farmer or rancher & materially involvedMust cultivate, operate or manage a farm or ranch for gain of profitFarming or ranching does not include timber or forestry productionDoes not include people who receive a fixed rent in cash or produce from a farm operationIncome Tax ManagementAttempts to maximize after tax profitsIncludes completion and filing of the correct tax formsTax accountants are used for this taskChoosing the Best Accounting SystemAdopt the system that is best suited to your situationRemember the two types of accounting used by farm and rancher managers areCashAccrualCash Accounting MethodIncome and expenses are recorded in the period in which they are actually received or paidInventory plays no major roleIncome is taxed when it is received and expenses are deducted when they are paid.

Cash Accounting MethodAdvantagesDisadvantagesEasierFlexibleSimpler than the accrual methodInaccurate measure of profitability for the time periodIncome variations

Accrual MethodRecords income when it is earned Records expenses when they occurUsed as an inventory in addition to the record of receipts and expensesAn increases in the year end inventory is treated as taxable income A decrease in the inventory reduces taxable incomeAccrual Method AdvantagesDisadvantagesAccurate measure of profitability during the periodReduces variations in income

Requires more record keepingCan create tax liability from items not yet sold

Income & ExpensesSummarized on Form 10401040 is divided into 2 partsFarm IncomeFarm ExpenseSee p. 9-5

Farm IncomeLines 1-10 on form 1040IncludesSales of livestock and other items purchased for resaleSales of livestock and crops raisedGovernment payment programsPatronage RefundsCrop Insurance ProceedsCustom Hire

Farm ExpensesLines 12-34 on Form 1040IncludesFeed, seed, fertilizer, fuel & laborDepreciation, rent and interestRepairs, taxes, utilities, storage

Net Farm ProfitGross income (line 11)-Total Expenses(line 37)If there is a net farm profit it is included in taxable incomeIf there is a net farm loss it can be used to offset other income

DepreciationSpreads out the value of assets over the period they are usedDepreciation of assets allows for the loss in the assets valueLosses in value are caused byWear and TearObsolescence due to new technologyDeterioration due to the elements of natureDepreciationThe proportion of the original cost to be depreciated in any one year is largely a matter of judgment and financial managementAspects that influence financial managementInfluence deprecation has on income taxesDesire to have the undepreciated value of an asset reflect the resale value of the assetDepreciation allowance taken in any year reflects the actual decline in the value of the assetTherefore net worth statements show the ACTUAL value of depreciable assetsGuidelines for Determining Property Subject to DepreciationDepreciable farm property includes all assets used in the business of farming that have a useful life of more than 1 year.Only assets which have a limited and determined useful life may be depreciated.Capital expenditures for assets which do not have a determined life, such as land or leasehold interests which are continuously renewed are not deductible. Tax benefits of these assets are not realized until they are sold or lost,Factors to Know Before Figuring DepreciationBasis- What is the basis in the property? This includes the cash paid or the cash difference paid plus the depreciable balance of their trade-in.When is the property put into service.Which method of depreciationis used.Methods of DepreciationModified Accelerated Cost Recovery System (MACRS)General Depreciation System (GDS)In IRS publications depreciation is referred to as recovery costFarm assets fall into 4 categories3 year5 year7 year20 yearRegular MACRS for Personal PropertyDetermined by multiplying the statutory percentages for that class of property by the cost basis of the item.See p. 9-7Section 179 Expense DeductionRead p. 9-8-9-9Other Characteristics of Depreciation Income tax benefits arise because the cost of capital asset is recovered over the useful life of the asset. The shorter the life assigned to the asset, the quicker the income tax benefit is received.Raised livestock may not be depreciated when the cash accounting method is used because all costs have been deducted as cash expenses.Nonbreeding livestock in inventory may not be depreciated using the cash accounting methodExpensing will affect cost recovery by reducing the cost basis of the property.Strategies to Increase Taxable Income Postpone expenditures and investments until after the beginning of the next tax yearSell marketable grain and livestock before the end of the tax yearWork with suppliers to pay bills after the beginning of the next tax yearDo not use section 179 expensing for depreciable propertyDo some off-farm or custom workStrategies to Reduce Taxable IncomePostpone some sales to next yearUse deferred sales contractsBuy NEEDED machinery, equipment, and other supplies BEFORE the end of the tax year to get depreciation.Use section 179 expensing for the maximum on depreciable property.Make advanced purchases of feed and fertilizer.Special Tax SituationsSee table D p. 9-11

Income Tax Differences Between Types of FarmsPrimary Income Tax DifferenceSole ProprietorshipPartnershipSCorporationSubchapter CCorporationFed. Tax RateEarnings taxed as personal income to ownerDistribute earnings, then taxed as personal income for each ownerDistribute earnings to shareholders; earnings taxed as personal income for each shareholderUndistributed earnings taxed only once, usually lower rates; distributed earnings twice (1) as part of earnings of corporation and (2) personal income to shareholdersNet Operating LossOperating loss offsets other income for ownerOperating loss offsets other income for ownersOperating loss offsets other income for shareholdersOperating loss can not be passed to shareholders; can be carried over to offset corporate incomeSocial Security TaxSelf-employment taxSelf-employment taxesRequire both corporation and employee to pay SS taxRequire both corporation and employee to pay SS taxState Income TaxOwners incomeOwners share of incomeStockholders share of incomeDistributed earnings, (dividends, corporate income, franchise taxSocial Security Taxes and Benefits

Agricultural CoverageGenerally covered by Social SecurityEarnings must come from employment or self employment

Agricultural LaborFarm employees have SS deductedFarm employer pays into employees SS account

Farm Employers and Employees Must Pay SS tax whenThe employee receives cash wages of at least $150 from any one farm employer during the calendar yearThe employee works for any one farm employer on 20 or more days for cash wages computed on a time basisThe employer pays wages of $2500 or more during the year to all employeesFamily LaborCertain family situations allow for no tax being due and no benefits resultingA spouse working for a spouseA parent working for a child unless the parent works in the childs trade or businessA child under 21 works for his or her parentDefining Ag LaborAll the work that is performed on the farm or ranch in employ of any person

What is an Employee??As defined by Social Security Law:An employee performs services for another, and is subject to the control of the employer.

Independent ContractorsOne who agrees to perform certain services for a fixed priceContractor must meet the specifications of the employerManner of doing the job and details is retained by the contractorIndependent contractor is the employer of his own employeesMust also pay self-employment taxes and employer taxes for employeesExample: professional electrician that is hired for a fee to repair an irrigation well pumpSelf-Employed FarmersMust pay self employment taxSelf employment tax is based on the net earnings from the farm businessThis is shown on schedule F (Form 1040)It is computed on schedule SE (Form 1040) and paid when the farmer files his income tax returnChildren may also have to pay self-employment tax is they carry on an activity of their own such as 4-H or FFA and have a net earning of $400 or moreEmployers of Agricultural LaborEmployers of agricultural labor are responsible for several administrative task. They mustHave an Employers Identification Number which is used on all forms that report the employers Social Security tax paymentsKeep Records of each employees name, social security number, cash wages, daily records of time worked, basis of payment and the amount deducted as the employees share of the social security tadWithhold tax from the employees wages.Make reports to the IRS by Jan. 1 each year and send a W-2 for showing that employees wages and taxes withheld to the employeePay Social Security taxes levied upon employer and employeePay Social Security taxes on a periodic basis, depending on the amount collected.Social Security Benefits and MedicareTypes of benefitsOld age and survivorSurvivor DisabilityHospital & medical (Medicare)OldSocialSecurityBenefitsOld AgeHospitalAndMedicalDisabilityEstate Taxes Also called inheritance taxFederal Govt. levies a gift tax on transfers during life and estate tax at deathInheritance tax is generally collected by state govt.Estate PlanningPlanning the acquisition, enjoyment, and distribution of property for the benefit of the familyWills are a form of estate planningA will or some form of formal estate planning is needed by everyoneWithout the state will distribute property as it sees fitEstate TransferDeath forces an estate transferAlways problems with this due toInheritance rights and interests of children in parents propertyProblem is frequently complicated by having to provide for a widow and children and the desire to treat all children equallyParents also need the farm to provide income and support in old ageDue to these problems families often delay planning until it is to late

Unified Federal Estate & Gift TaxFederal government levies a gift tax on transfers during life and an estate tax on transfers after deathRate schedule is the same for both

Income Taxes Affect Estate PlanningAlso a concern in tax planningIncome tax savings during life may create additional capital to be used or passed onThe way wills or trust are drawn up will also determine how much the beneficiaries will have to pay in income tax

AssignmentLook up South Dakotas Law in regard to inheritance tax and print the information off for class discussion.