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Time for Year-End Farm Tax Plans

by Bev Berens

Published: Friday, December 2, 2022

Shoring up the 2022 tax strategy is on most growers' high priority list during the run to year's end. Farm incomes are projected to be high, and now is the time to plan ways to reduce the year's tax liability, according to Bob Rhea, CEO of Illinois Farm Business Farm Management. He discussed tax strategies during last week's Illinois State University Farmdoc webinar.

"We have the next six weeks to get the best answer we like on those tax returns," Rhea said.

The tax code was re-written in 2017 and will be sunset in the fast-approaching year of 2025. Some tax benefits will also be lost in 2023. Rhea advises now is the time to strategize and benefit from present tax savings that will require legislation to retain beyond their established deadlines.

For example, corn yield is coming in at an average of 185 bushels per acre, five bushels higher than projected yield. Prices are averaging around $6.50 per bushel, a dollar higher than in 2021. The result on a 1,000-acre corn crop is a potential increase in gross revenue of $212,000 for the year.

"Tax planning is important to protect as much of that gross revenue as possible against added tax obligations," Rhea said.

Between 1980 and 2006—the pre-ethanol years—farm incomes, while low, didn't experience giant fluctuations. The production and demand for ethanol changed the landscape, with crop incomes on the rise, but also experiencing extreme highs and lows. 2012 was the best income year ever for corn growers, and a mere three years later, the income sank to an all-time low.

Tax rates have changed dramatically over time. In 1978, the highest tax bracket was 78%, while today's cap is 37%. Rhea noted that while the rate was high, the total money being taxed was far less than today's taxable dollars.

In breaking down an adjusted gross income (AGI), Rhea suggests $130,000 as a goal, designating $80,000 to family living, $20,000 to income tax liability—a non-deductible expense for the individual—and principal payments above depreciation of $30,000.

"If the AGI is less, we are essentially deferring tax until later, and we don't know what tax rates will do in the future."

Among the tax benefits set to expire in three years is the The Qualified Business Income Deduction (QBID), which lowers the highest tax rate paid to 29.6%. The current rate for income up to $340,000 is 19.2%. QBID deductions are any qualified business income activity that shows on a Schedule F, Schedule C, a 4797 sale of equipment, or other qualifying income through partnerships, individuals, and S-Corporations. There are some limitations, including QBID carryover losses, which do not qualify, and the QBID cannot exceed 20% of taxable income minus capital gain income.

Depreciation provisions are also very favorable, including a bonus depreciation of 100% through 2022, including new and used machine sheds if placed in service or state of readiness for intended use. Material stacks awaiting construction would not qualify for the 100% deduction, nor would equipment purchased but still in progress on an assembly line.

Rhea encourages a conversation with a tax professional to sift through any depreciation opportunities missed such as undepreciated tile from land purchases or equipment paid through dealer financing. Farm trucks that are at least 50% farm use and meet minimum weight requirements also qualify for the 100% bonus depreciation.

Individual state's depreciation tax rules may or may not be consistent with federal rules, and a large capital gains tax savings may not be reflected on a state tax liability.

Capital gains on equipment sold was historically not an issue, but some growers may run into the issue this year. Capital gains tax rates for 2022 are 0% for a married couple filing jointly on capital gains of up to $83,350, 15% up to $500,000 and 20% above a half million..

If an 80-acre tract were sold for $18,000 per acre, and the initial buying price was $4,000, there is a capital gain of $14,000 per acre, and a total of $1,120,000 capital gain. The federal tax rate on that gain is $185,637 today. If it were ordinary gain, the tax liability would be $339,366.

Using grain as gifts to charity or to pay employees saves federal, state and self-employment taxes. A clear proof of transfer is required to make the transaction legal and is a great tax saver as opposed to selling the grain and writing a check to a charity, which could result in zero tax advantage. Grain as wages saves both employee and employer self-employment tax.

CCC loans can generate cash without taking an income to take advantage of pre-paid expenses. They can be used as a taxable grain receipt, or as taxable income if needed, providing some strategy options.

Multiple deferred payment contracts create the flexibility to move income from new year to the prior year, and decisions on when to move the income can wait until early in 2023, allowing for more flexibility as the tax documents are finalized.

Higher than normal farm incomes can have some unintended consequences like additional taxes on social security benefits and Medicare surcharges down the road.

Contributions to HSA, IRA and SEP plans are qualified business expenses, but must remain within contribution limits.

A tax saving opportunity which, despite sounding too good to be true according to Rhea, is utilizing a pass-through entity to pay taxes. For example, a partnership with $200,000 taxable income would be taxed at a flat rate of 4.95% in Illinois, a total of $9,000 when paid by the individuals. When paid by a pass-through entity, the federal tax is reduced by $2,178.

Income averaging from a three-year historical position can provide some savings if there are holes to fill in income categories from previous years. Rhea says that while savings can be found with income-averaging, the benefits are usually lower than expectations.

Exemptions are set to increase for 2023, some of which is based on adjustments for inflation.

Rhea stresses the importance of working with a tax professional to navigate what is best for 2022, while considering new exemptions for 2023 and what is set to expire in 2025.

"It will help keep surprises minimized when it comes to tax liabilities," he said.

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