Tax Plans in Drought Year Require Added Attention

Time with adviser will be well spent in a year with record farm weather, and changes to temporary rules.

Published on: Sep 20, 2012

2012 has been another unusual year for farm and ranch owners and operators! The drought that affected most of the United States could create a number of issues as we look at your operation’s taxable income for 2012 and 2013.

Here are a few important things to consider for 2012:

Make long range taxable income plans. The new farm bill appears to eliminate direct payments to producers and landlords. We’ll still get payments in 2013 but there likely will be no direct FSA payments during calendar year 2014 under the proposed new FSA farm program. Our recommendation is to “push” the higher incomes of 2012 and 2013 into 2014 when we’ll likely see lower farm incomes. Manage your income through deferral of income and using prepaid expenses to hit your target income.

INTERESTING YEAR: 2012 has been another unusual year for farm and ranch owners and operators! The drought that affected most of the United States could create a number of issues as we look at your operation’s taxable income for 2012 and 2013.
INTERESTING YEAR: 2012 has been another unusual year for farm and ranch owners and operators! The drought that affected most of the United States could create a number of issues as we look at your operation’s taxable income for 2012 and 2013.

2012 is the last year of generous write-offs for equipment purchases unless Congress acts. Section 179 depreciation will drop from $ 139,000 in 2012 to $ 25,000 plus an adjustment for inflation in 2013. For 2012 you can still deduct 50% of the purchase price of new qualified assets (agricultural assets with life of 20 years or less) in the year of purchase for assets purchased in 2012. The 50% bonus depreciation will not be available in 2013 unless Congress takes action…which doesn’t appear to be likely!

Will leasing be an option for a higher equipment expense deduction in the future? The answer is “it depends”. If you do intend to make leasing a part of your tax management strategy make sure your lease is a “qualified” lease and not a lease-purchase contract. The Internal Revenue Service thinks that some leases look very much like conditional sales contracts, under which the farmer is buying the asset. If the farmer  is acquiring an asset, the transaction is a sale, and he deducts depreciation and interest expense instead of the lease payment.

In determining whether the lease is more like a sale, the Service looks to (1) whether the rents and the option price to acquire the property at the end of the lease roughly equal the purchase price, plus interest; (2) whether high rents in the early years of the lease approximate the purchase price, and the farmer retains the use of the asset in later years at a relatively low rental; (3) whether the farmer will acquire title at the end of the lease for a nominal price, and the rental payments are credited as a substantial part of the purchase price; or (4) whether, on the face of the whole transaction, the farmer obtains the use of the asset or the ownership of it by payments that do not conform to the reasonable rental value of the asset.

Careful consideration of the recovery of cost of machinery through depreciation, plus the deduction for interest or carrying charges, may make the lease arrangement less attractive.

Crop insurance questions rise

We are receiving a lot of questions on crop insurance because of the 2012 drought.

First, can you defer the reporting of crop insurance payments received in 2012 to 2013? The answer is: It depends. Can your records show that you normally sell 50% or more of your crop in the year after it is produced? If so, then you can defer reporting the proceeds of crop insurance received in 2012 for the 2012 crop until 2013. The decision to defer crop insurance proceeds into 2013 is an all or nothing proposition. You cannot elect to defer a percentage of the crop insurance but must defer all or none.

Second, you may defer only the portion of the crop insurance that relates to yield loss and not to the revenue portion of crop insurance. Some crop revenue insurance products make payments if the price of a crop declines between planting and harvest. The portion of the crop insurance that relates to price protection cannot be deferred. How do you know how much of the proceeds to defer into 2013? The answer is that you must calculate the portion of the crop insurance proceeds that directly relates to the yield protection.

Tax change on Medicare payments

Are you on Medicare and still actively farming and paying self-employment tax? The IRS recently announced that all Medicare parts (not just the supplemental medical insurance of Medicare Part B) are insurance constituting medical care, and that all Medicare premiums may be deductible as self-employed health insurance. Taxpayers are eligible to file an amended return for all open years (2009, 2010, and 2011) to get the benefit of this deduction.

Loss of funds to income tax is the poorest expenditure that you can make. We always recommend making an appointment with your tax preparer to make sure that you hit the taxable income goal for your agricultural operation. You still have the opportunity to defer income into 2013, increase expenditures, or even increase your taxable income for 2012 as long as you act before December 31.

Readers can receive a sample copy of the August 2012 Farm Tax Saver that includes a complete discussion on crop insurance reporting. You can get a copy by emailing circhelp@farmprogress.com or by calling 800-441-1410.

- Darrell Dunteman is editor of Farm Tax Saver a Farm Progress monthly newsletter focused on ag tax issues, and he is the Management Coach for Farm Futures magazine. You can subscribe to Farm Tax Saver by visiting www.farmprogress.com/subscribe.