This is the complete version of the tax story we featured in our November issue. In addition, Author Trenna Grabowski has prepared a handy worksheet that includes important numbers you can use. Just click on 2006 Tax Planning Numbers.
Measure the dollar benefit per hour spent and tax planning is one lucrative way to spend your time. Most individuals and businesses can benefit from year-end tax planning. If you're on a cash basis accounting system, due to the nature and timing of cash flows, you have opportunities for tax deferment or acceleration not available to most taxpayers. It's time to spend a few hours and benefit from those opportunities.
Best starting point is accurate year-to-date records, and a projected depreciation schedule for the farm's assets. If you use a tax professional, schedule an appointment for an in depth planning session. Most tax pros will have more time available in the fall to devote to your questions and “what ifs” and to clear up any confusion you might have and to work on the tax ramifications of various scenarios.
If you don’t use a tax pro, the IRS web site can provide you with a wealth of information. Just visit www.irs.gov. To find articles, questions and publications specific to farmers, click on Businesses, then on Small Business/Self Employed. Then look down at the left hand side and click on Farmers. Or use this link www.irs.gov/businesses/small/farmers/index.html.
Here you will find hot links to Tax Tips, Tax Laws and Regulations, Audit Technique Guides and much more - all agriculture-specific. For general reference for tax reporting for agriculture, download publication 225, The Farmers Tax Guide. It is updated every year. The 2005 version is still available. The 2006 version should appear on the web site sometime in November.
The IRS web site has won numerous awards for ease of use. You may download most IRS publications, as well as forms. Although the 2006 forms are released as various times and may not be available yet, you can download and print last year’s versions as a guide and get the 2006 form as they are released and made available on the web site.
So, what’s new this year and what do we need to watch for? Congress has been busy in the tax area. The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) enacted May 17, 2006 includes an extension of Alternative Minimum Tax (AMT) relief, an extension of the enhanced expensing (code section 179) rules, an extension of the 15% maximum capital gains tax rate and a change in the “Kiddie tax” rules, raising the age threshold to 17. The Pension Protection Act of 2006 (PPA) makes changes to funding standards and deduction limits for pension plans, extends some of the 2001 tax law changes due to expire and calls for more strict requirements for deductible charitable contributions. Congress is still in session as this is written. There could be more action on expiring provisions relating to sales tax, college tuition deductions and teachers’ classroom supplies, but whether, or if, those changes will occur is not known.
Farm income averaging is still available. This allows a qualifying farmer to make use of lower income tax brackets that were not utilized in the preceding three years. Pull Schedule J and instructions from the IRS website. If this looks like a high income years, income averaging could save a considerable amount in federal income tax.
Domestic Production Activities Deduction
New in 2005, the domestic production activities deduction is available for most farming operations. It calls for a deduction of 3% (goes to 6% for 2007) of qualified production activity income, limited to 50% of qualified wages paid. The calculation is on Form 8903, which you may download and use for your tax planning.
The first-year expensing election, sometimes called the “179 election” for its IRS Code section, allows for an immediate write off of up to $108,000 for newly acquired machinery and equipment used in the active conduct of a trade or business. Rather than recovering the cost of qualifying assets purchased in 2006 over a period of years, you may take up to $108,000 on your 2006 return. The write off amount is limited to taxable income from a trade or business. The wages of both spouses also count as taxable income for this purpose. You do lose the deduction, dollar for dollar, if your purchase of qualifying items exceeds $430,000 during the year. Originally set to revert to $25,000 in 2008, the TIPRA authorized the enhance amount ($100,000 adjusted annually for inflation) through 2010. The expensing election is a great tool. You don’t have to make a decision on how much of it you will use until you actually file your return. You may also use “20/20 hindsight” to amend your prior year’s return if, in light of this year’s projections, you should have taken more or less 179 expensing on that return.
Alternative Minimum Tax
The alternative minimum tax (AMT) originally created to be sure that high income individuals pay some tax, has not kept pace with inflation. Therefore, ordinary taxpayers are often hit with this unexpected tax. Taxes are calculated under the regular rules and the AMT rules. If the AMT rules result in more tax, you pay the higher amount. The AMT exemption for 2006 is $62,550 filing jointly and $42,500 for unmarried individuals. The exemption phases out beginning at $150,000 for married couples and at $112,500 for unmarried individuals. The AMT rate is 26% of the taxable income (after the AMT exemption) up to $175,000 in AMTI income and 28% of the taxable income above $175,000. The AMT calculations are complex.
When making a lease versus purchase decision, you may want to consider the possible AMT ramifications. There is generally no adjustment for business lease payments, but the AMT has a different depreciation system than regular tax. It is possible that a sufficiently large difference between depreciation for AMT and depreciation for regular tax may through you into actually having to pay alternative minimum tax.
Kiddie Tax Rules
Farm kids are often part of the farm labor force and savvy parents have learned that writing checks to the kids and issuing W-2s can result in a good tax break for mom and dad. In the past, you did have to be concerned that the unearned income (interest on savings, dividends and so on) of farm kids under age 14 would be taxed at the parent’s tax rate (after certain exemptions). The age threshold has been changed (for tax years beginning in 2006, so it applies to this year) to under age 18. Adding insult to injury in the form of a higher tax bill, now your 17 year old may be subject to “Kiddie tax.”
Livestock Replacement Period Extended
You normally have four years, under §1033, to replace livestock you were forced to sell because of drought. If the animals are not replaced during that time, the sale must be reported on Form 4797. The livestock must have been held for draft, dairy or breeding and the area must have been a federally declared disaster area.
The IRS has now issued Notice 2006-82, providing additional time to replace livestock sold as a result of drought. The notice explains that if the four-year replacement period was due to end on December 31, 2006, the replacement period is extended to December 31, 2007 provided that “for any weekly period included in the 12-month period ending on August 31, 2006, severe, extreme or exceptional drought conditions were reported for any location in the county that experienced the drought that forced the sale of the livestock or for any location in a neighboring county. The replacement period may be further extended if the drought conditions persist after August 31, 2006.”
The Service will publish a list of counties that qualify for the 12-month period ended on August 31, 2006. Working with the National Drought Mitigation Center at the University of Nebraska-Lincoln, the Service plans to publish a list in September each year. You can visit the National Drought Mitigation Center and view drought maps at www.drought.unl.edu.
Conservation Contribution Limit Boosted
The charitable deduction limit goes from 30% of adjusted gross income to 50% of adjusted gross income for qualified conservation contributions, provided that the contribution does not prevent the use of the donated land for farming or ranching purposes. The charitable deduction is raised to 100% of adjusted gross income for eligible farmers and ranchers. It allows a farmer or rancher to carry forward the deduction for 15 years, provided he is a farmer or rancher in the year of the carryforward.
You may give up to $100,000 in otherwise taxable funds from your individual retirement account to a tax exempt organization. This provision has a brief window and is effective only for 2006 and 2007.
Your business may donate food inventory and claim a deduction for the lesser of your basis plus one half of the difference between fair market value and basis and twice your basis in the contributed inventory. This one also is only good for two years, 2006 and 2007.
There is a recapture provision for the tax benefit for charitable contributions of exempt use property that the organization does not use for an exempt purpose.
You cannot give “junk” to a charity and take a deduction. No deduction is allowed for charitable contributions of clothing and household items if the items are not in “good used condition or better.” They can also deny a deduction for an item which has “minimal monetary value.”
If you plan to include the $1 you throw into Santa’s bucket outside of various stores, you’ll have to ask for a receipt. In the case of a charitable contribution of money, regardless of the amount, the donor must maintain a cancelled check, bank record or receipt from donee organization showing the name of the donee organization, the date of the contribution, and the amount of the contribution.
- Trenna Grabowski is an Illinois certified public accountant and editor of Farm Tax Saver, a monthly farm-focused tax information newsletter. Learn more by clicking on "Subscription Services" at the left.