Tax plan now to avoid problems later

Farms that have seen good commodity prices and profits along with Dairy and Beef prices at all-time highs are vulnerable for some real tax issues in 2014.

It may seem early in the year for tax planning, but for dairy and beef operators, this preparation should have started a couple months ago. For many years, farms have faced the challenge of managing their farm income to avoid income spikes or failures. Both of those scenarios can have negative impacts on the farm’s financial position and annual tax liability. For dairy farms, 2014 is on track to be one of the highest average milk price years on record. Coupled with Michigan dairy farms producing more milk per cow and incomes could be very high.

Michigan State University Extension recommends estimating your farm’s tax situation now. You can find a simple one page worksheet is available to estimate farm tax situation. The worksheet was designed for 2013 but will be a close estimate of where you should be for 2014 at this point in time.

It is always a good idea to pay down debt when the opportunity presents itself, and many farms have focused on paying down loans during this profitable time. This practice may be an issue in calculation of this year’s tax liability. Debt payments are made with after-tax dollars as the principal payments are a cash flow expense but not a tax deductible expense. Paying down loans will help to empty the checking account, but the debt payment creates a tax bill that you will not see until tax planning time or tax reporting next February.

Many farms have been using the option to pre-purchase or pre-pay some farm input needs during the last few months of the year for use in the production of next year’s commodities. This is a great tool as it often allows you to take advantage of early order discounts and most important to lock in the cost of those inputs. If you have been using this practice in the past, you may find your farm in the position to again repeat this practice again this year. These early purchases do require the farm to manage their cash flow to make this possible. Cash flow may be an issue if the farm is attempting to prepare for inputs while also delaying or deferring income during the last few months of the year.

A tax management tool that has been widely used in past years was the use of Section 179 Direct Expense depreciation option as well as the bonus depreciation. In previous years, those options allowed up to $500,000 be used for Section 179 before phasing out at $2 million. That option is no longer available to that same limit. Unless congress and the President take action, the $500,000 option presently stands at $25,000 for the 2014 tax year with an adjustment for inflation.

Many farms have also used bonus depreciation that was available in past years. Presently, there is no bonus depreciation available to be used for the 2014 tax year. In the past these tools were extensively used to help level a farm’s income from one year to the next along with pre-pays and other tax tools. For those farms that may find themselves again with higher than expected incomes, some of these tools have been significantly reduced or are no longer available. This is especially true when one considers Section 179 and bonus depreciation have been used so extensively that a farm may find that they have minimum carry-over depreciation. This will require farms to begin to prepare for tax planning earlier researching for other management strategies that may be necessary.

The key point to remember is that expense and income management together is an important farm financial management strategy and that 2014 is a year where planning will need to start early. You may want to contact your tax advisor soon. For Michigan farmers, you can also contact a farm management educator with Michigan State University Extension.

Additional resources and information on this and other farm management topics are available at the Michigan State University Extension FIRM web page