Tax planning in the summer? Starting early could yield results
Taking the time to evaluate your tax situation now can yield big dividends when you finalize your tax management plan at the end of the year.
We tend to think of tax planning as something we do in December, particularly because this time of year is busy. However, a mid-year check on your tax planning can have a real benefit by the end of the year. Despite increasing input costs, a year with high commodity prices and potentially good yields means tax planning will likely be very important. Since most farmers are cash-basis filers, a little looking ahead can provide significant flexibility in optimizing your tax management choices.
Often, we rely on depreciation from current year equipment purchases to manage taxes at the end of the year. However, taking too much depreciation in the year of purchase can limit your future tax planning choices. In addition, it can jeopardize your farm’s cash flow in future years. Once the equipment is fully depreciated, future debt principal is effectively paid with after-tax income.
Here are some other management strategies you can use in your mid-year tax planning:
- Consider the farm income you have already received, as well as that which you expect to receive before year-end. Optimizing the price of the products you are currently contracting is critically important, but the tax implications of the year you’re paid can be significant. Remember that self-employment tax is 15.3% of your taxable farm income, in addition to the income tax liability. Note that cash receipts count as income when the funds are available to you; not when the check is cashed. Thus, the structure of the contract can determine which year the income is taxable.
- The timing of paying expenses can be a useful tool in tax planning. Delaying payment on production expenses can help with cash flow, but the deductibility of those deferred expenses depends on who is doing the financing. Purchases financed with a separate financing company are deductible when the purchase is made. However, purchases on the vendor’s account are not deductible until you write the check.
- Prepaid expenses are a common and effective tax management tool that can also reduce costs in the coming year. However, paying these expenses requires that your business have the available cash. Considering now how best to manage your farm’s cash reserves and financing strategies can make a big difference in your ability to prepay expenses.
- And of course, this year’s asset investments provide depreciation opportunities. For most farms, equipment purchases allow flexible depreciation through Section 179 direct expensing. Buildings and improvements have some flexibility as well but can have more complicated issues. Depreciation choices are great for fine tuning your tax management plan alongside other management strategies.
A cash flow projection made at the beginning of the year can make summer tax planning quite straightforward. You can compare your current accounting records to the projection to determine whether you’re ahead or behind your plan. An annual financial analysis, such as the one through the Michigan State University Extension financial benchmarking program, can help make sure you have an accurate and useful projection.
All is not lost if you don’t already have a projection for this year’s income and expenses. You’ll need your current year-to-date accounting records, being sure to include any carryover old crop sales from early in the year. Check with your tax preparer for any deferred income and for your depreciation from prior year purchases.
Putting forth the effort to do some mid-year tax planning can help to ensure that you are not boxed in at the end of the year. A good tax plan can also make it easier and more effective to manage your taxes in future years. Your local MSU Extension Farm Business Management Educator can help answer your tax planning questions. The MSU Extension TelFarm program, which provides accounting support and farm financial analysis, offers tax planning as part of its services. As always, consult your trusted tax professional for advice specific to your farm.