by Rob Holcomb, EA, and Megan Roberts, Extension educators
Earlier this month, the Extension Ag Business Management team presented a tax planning webinar addressing major financial and tax policy updates from 2020. Our webinar concluded with tax planning strategies for the end of the year. With average farm incomes predicted to be up in 2020, tax planning takes on additional importance this year. You can watch our webinar here for a detailed discussion or continue reading this post for a brief tax planning summary. Please note this webinar was recording December 3, 2020 and new legislation from Congress significantly effects some of our CARES Act analysis.As we move into the final days of 2020, now is the time to complete your tax planning decisions by analyzing final income projections and making expensing decisions before December 31. Your effective tax rate is an important consideration in these decisions. The primary strategies for end of year tax planning are:
First, we want to do a quick refresher on income tax rates. The chart shown above is a helpful tool when evaluating year-end tax planning decisions. The chart visualizes the overall federal tax rate at various income levels, and shows why properly done income or expense adjustments can be so beneficial at the end of the year. The chart is prepared for the married filing joint tax status.
Accelerated depreciation is a common tax strategy for agricultural producers. Minnesota’s October 21, 2020 tax law change brought Minnesota into conformity with the federal Section 179 depreciation expensing, so this strategy has received additional attention this year. We discuss the full details of Section 179 conformity in another post. Minnesota taxpayers should note the October law change did not address conformity with federal bonus depreciation rules. There is still an add-back required in Minnesota if bonus depreciation is used on federal tax returns. Furthermore, remember the Tax Cuts and Jobs Act of 2017 eliminated like-kind exchanges for personal property, including machinery, equipment, and vehicle trades. These types of trades are taxable and will likely trigger ordinary gain due to Section 1245 depreciation recapture.
Prepayment of expenses such as seed, fertilizer, fuel, and chemicals is another common end of year strategy for cash-basis filers. However, pre-payments must be done properly to be allowable expense deductions in 2020. Simply paying money on your account is insufficient. Pre-payments must be for actual purchases and those purchases must not exceed 50% of the taxpayer’s total schedule F expenses (including depreciation).
Deferred sales push income from this year’s production into next year. Executed properly, deferred income sales allow delivered commodities to be paid in the following year via rules governing installment sales. The producer must have a binding contract with their buyer and must not have any constructive receipt of income prior to January 1. Deferred sales are not without risk, essentially the seller (i.e. the taxpaying farmer) becomes an unsecured creditor to the buyer. If the buyer goes out of business before the payment occurs, the seller may be last in line for recoupment of dollars owed.
Crop insurance deferral is another income deferral strategy. The crop insurance deferral election applies to destruction or damage to crops that results in an insurance or disaster payment. Revenue Rule 74-145 and the Nelson v. Commissioner court case (2008) requires taxpayers to show that more than 50% of income from each damaged crop(s) would be reported in the following year in an ordinary year.
- Accelerated depreciation
- Expense prepayments
- Deferral of income
- Crop insurance deferral
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| 2020 Income Tax Rates Graphical Representation, source Rob Holcomb |
First, we want to do a quick refresher on income tax rates. The chart shown above is a helpful tool when evaluating year-end tax planning decisions. The chart visualizes the overall federal tax rate at various income levels, and shows why properly done income or expense adjustments can be so beneficial at the end of the year. The chart is prepared for the married filing joint tax status.
Accelerated depreciation is a common tax strategy for agricultural producers. Minnesota’s October 21, 2020 tax law change brought Minnesota into conformity with the federal Section 179 depreciation expensing, so this strategy has received additional attention this year. We discuss the full details of Section 179 conformity in another post. Minnesota taxpayers should note the October law change did not address conformity with federal bonus depreciation rules. There is still an add-back required in Minnesota if bonus depreciation is used on federal tax returns. Furthermore, remember the Tax Cuts and Jobs Act of 2017 eliminated like-kind exchanges for personal property, including machinery, equipment, and vehicle trades. These types of trades are taxable and will likely trigger ordinary gain due to Section 1245 depreciation recapture.
Prepayment of expenses such as seed, fertilizer, fuel, and chemicals is another common end of year strategy for cash-basis filers. However, pre-payments must be done properly to be allowable expense deductions in 2020. Simply paying money on your account is insufficient. Pre-payments must be for actual purchases and those purchases must not exceed 50% of the taxpayer’s total schedule F expenses (including depreciation).
Deferred sales push income from this year’s production into next year. Executed properly, deferred income sales allow delivered commodities to be paid in the following year via rules governing installment sales. The producer must have a binding contract with their buyer and must not have any constructive receipt of income prior to January 1. Deferred sales are not without risk, essentially the seller (i.e. the taxpaying farmer) becomes an unsecured creditor to the buyer. If the buyer goes out of business before the payment occurs, the seller may be last in line for recoupment of dollars owed.
Crop insurance deferral is another income deferral strategy. The crop insurance deferral election applies to destruction or damage to crops that results in an insurance or disaster payment. Revenue Rule 74-145 and the Nelson v. Commissioner court case (2008) requires taxpayers to show that more than 50% of income from each damaged crop(s) would be reported in the following year in an ordinary year.
