It has been over 30 years since we last saw major tax reform. Here’s what to keep in mind this year, which varies slightly from previous tax seasons.
1. Plan on not filing by March 1. Many farmers automatically file and pay their income tax return by March 1. However, this year, it is likely much better to make your estimated tax payment on Jan. 15, and then file your income tax return on April 15.
The IRS is still finalizing the new law and related tax forms, which will make it extremely difficult for tax preparers to complete returns by March 1. The required payment due on Jan. 15 is the lesser of:
- 100% of 2017 tax liability.
- two-thirds of this year’s expected liability.
If you miss it by a little bit, the penalty is based on the new 6% interest rate from Jan. 15, 2019, until the tax is actually paid. Here is an example:
Farmer Smith paid tax of $45,000 in 2017 and expects to pay $30,000 this year. He elects to pay $20,000 on Jan. 15. His final tax bill is $33,000, which is paid on April 15. The required payment was the lesser of $45,000 or $22,000 (2/3 or $33,000). The underpayment is $2,000 and the penalty is 6% of this number for three months or about $30. As you can see, the penalty was minor. If Farmer Smith had elected not to pay anything and file by April 15, the penalty would have been 6% of $22,000 for three months or about $300.
2. Remember your optional self-employment method. This year, many farmers who file a Schedule F tax return might show a large Schedule loss with an offsetting larger Form 4797 gain from trading in farm equipment. Farmers can no longer trade farm equipment and not report a gain. However, 100% bonus depreciation will allow farmers to deduct the trade-in amount and still report about the same amount of taxable income. However, this leaves the farmer with no earned income, which is required to provide for social security benefits.
Enter the self-employment tax method. Even if farmers show a $500,000 loss on Schedule F, they can elect to pay self-employment tax on $5,280 of their income. Here are two examples:
Example 1: Fred and Sally Benson have three kids under age 17. During 2018, Fred trades in $350,000 of farm equipment—a gain of $350,000 on Form 4797. Since Fred deducted the trade-in value, he shows a loss of $250,000 on his Schedule F. Under the old law, he would show $100,000 of earned income and owe $15,000 of self-employment tax on the earnings. Now, he gets no social security credit but owes no self-employment tax. Fred elects to report $5,280 of earned income resulting in about $800 of self-employment tax.
Example 2: Fred and Sally net only $24,000 of income and deduct their $24,000 standard deduction. They have zero taxable income. Since Fred and Sally have no earned income, they don’t receive the refundable child tax credit of $1,400 per child. However, by electing the self-employment method, they now have enough earned income to get all $4,200 back from the IRS. The only cost is the $800 of self-employment tax.
3. Don’t show losses. We can only carry a farm loss of $250,000 (twice that for married couples) back two years. And, we can only offset 80% of taxable income. This means we generally do not want to create a loss. There are smart ways to increase a farmer’s taxable income, such as to elect out of bonus depreciation and then use Section 179 to reduce taxable income to the optimal amount. Here’s an example:
Jim purchases $600,000 of new farm equipment. His income before any depreciation deductions is $500,000. He would like to report $100,000 of farm income to soak up the 10% and 12% tax bracket, etc. He elects out of 100% bonus depreciation and elects $350,000 of Section 179. The remaining cost basis of $250,000 generates $50,000 of tax depreciation which brings his farm income down to the optimal $100,000 level, leaving $200,000 of cost that can be depreciated over the next five years.
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA. He recently purchased a 185-acre farm. Driving his cousin’s combine is his idea of a vacation.