WVU Extension Service
Farm Management Specialist
This article was published in the November 2000 issue of the West Virginia Farm Bureau News
Fall finds most farmers busy getting ready for winter. Finding a little time during all the equipment and roof repairing, cattle processing, and firewood cutting for some tax management can repay the farmer with huge rewards.
High calf prices this fall and some U.S. Department of Agriculture and state assistance programs relating to the drought recovery has drastically changed the Schedule F income returns for many farmers. They report having more farm income than in almost any year they can remember. Farmers need to consider some end-of-year tax management strategies.
This time of year provides farmers an opportunity to actually change their tax liability. Although most financial activity is over, the calves are sold, and the harvest is completed, the farm accounting year doesn't end until Dec. 31. Every farmer could complete his or her tax returns now. But the tax deadline is months away, and farmers still have an opportunity to expend cash and reduce profit.
This opportunity is possible because most farmers use cash accounting. This means that the Internal Revenue Service views the year in which a farmer receives cash or pays an expense as the tax year. This is quite an advantage for the farmer who is willing to use it. Farm managers can actually make strategic purchases that will increase expenses and then effectively reduce their profit and thus reduce their tax liability.
With careful management, a farmer can purchase next year's supplies in this tax year and reduce his tax bill. There are guidelines pertaining to prepaid feed, seed, fertilizer, and similar farm supplies not used or consumed during the year. The farmer can deduct an expense for prepaid farm supplies that does not exceed 50% of other deductible farm expenses (those listed as regular expenses on the Schedule F) in the year of payment. The amount over the allowable 50% limit must be reported as an expense the next year rather than the current year.
The limit does not apply under two exceptions for farm-related taxpayers. (For Internal Revenue Services purposes, a farm-related taxpayer either makes his main home on a farm or his principal business is farming, or a family member meets either of the two conditions.)
The first exception allows a manager to claim prepaid supplies totaling more than 50% of the farm's usual total if the business experienced a major change in operations resulting from unusual circumstances. These would include a drought, flood, fire, or some other major occurrence like a herdwide disease outbreak. The second exception allows for the farmer to exceed the 50% level in one year to the point that the prepaid total for that year and the two preceding years does not exceed the 50% level of the deductible expenses for that year and the two preceding years. This exception means that a farmer who has never claimed any prepaid supplies can claim a greater amount equal to the 50% of the total of those years.
Feed is included in the prepaid farm supplies deduction if the feed purchase meets certain guidelines. But the regulations are more strict. It's obvious that there have been many creative interpretations to this provision. The feed purchase cannot be a deposit. It does not have to be delivered, but it has to be a binding contract complete with a description including tons and price. The purchase has to be a legitimate management decision where some other benefit is derived from the purchase other than tax avoidance.
The best example is buying feed in the fall to avoid paying a higher price later or buying it ahead to be assured of getting it because of a shortage. This provision does not allow farmers to take the prepurchase option for feed if the action results in a material distortion of the farm income. The manager must relate this to customary business practices, the time of the year the purchase was made, and how the purchase relates to other years. The feed section of the prepurchase provision demands a very careful look.
The prepaid option for the Schedule F should be considered very seriously. Farmers can always take a logical look at this provision and employ some very sound fall practices that can increase expenses and never have to stand the test mentioned above. The most sensible includes spreading lime, fertilizer, and chicken litter now. Materials that are consumed on the farm in any calendar/tax year don't apply in prepaid rules. repairing the roof or farm tractor in the fall can help one manage taxes.
Purchasing a tractor or major piece of equipment is the "old standby" as far as tax management is concerned. Farmers tend to overuse this option. Machinery constitutes a capital purchase that must be depreciated. If the property you purchase is expected to last for more than one year, you cannot deduct it in one year. Some options concerning the rate of depreciation will help the farmer reduce tax liability.
The most notable deduction farmers should consider in Section 179 of the Internal Revenue Code. This allows managers the option of deducting all or part of the cost of some qualifying property in the year it is placed in service. The list that qualifies as a 179 deduction includes tangible (not real) personal property and single-purpose agricultural and horticultural buildings. This means that machinery and equipment, agricultural fences, milk tanks, office equipment, and livestock all qualify for deductions.
Farmers who take the time now to organize their financial information have the option of reducing their tax liability. Farmers who wait until after their tax year has ended to consider their tax liability and their tax management have eliminated several of their tax management options. Farmers should always include a tax professional early in the process, too. Remember, when it comes to tax management, "A penny saved is a penny earned."