I work with a large number of closely held agribusiness operations and family farms in the region (mostly cash grain, dairy, swine, and beef producers).
As CPAs, we like seeing our clients save money and pay down debt. For our ag producers, we want to see them conserve capital and manage cash flows. This is especially important because the commodity markets continue to be volatile — annual tax planning and financial planning are critical.
Many families I work with see the farm as their retirement. Some have a gene in them that says paying taxes is bad. No one likes paying taxes, but it is a sign that you have a healthy business. What I think is a win for business owners is paying tax at the appropriate technical level — not unnecessarily paying too much tax. For instance, the 12 percent federal tax bracket seems to be cheap compared to the 37 percent federal tax bracket that one could face.
Using the tax code
Ag producers can pay themselves in a variety of ways and increase liquidity into retirement. The most common way is through a W-2 wages or family draw. Less common is through commodity wages or investing in their retirement through available plans.
Tax planning is an art form, and it requires some creative thinking as well as a strong understanding of your goals and the tax code. Currently, the tax code recognizes the difficult environment that farmers face and allows producers and industry tax practitioners to use a variety of tools to manage taxable farm income annually.
Useful tax planning tools
When we are working with agribusiness clients, some of the fundamental tools at our disposal include:
- Cash-basis accounting
- Deferring income on production-related crop insurance and deferring income using commodity contracts
- Prepaying inputs prior to year-end
- Using 199A deductions
- Section 179 and 100 percent bonus depreciation
- Farm income averaging and commodity wages and contributing to retirement plans
- Setting up charitable remainder trusts for retiring ag producers who have a significant amount of grain deferred to future years
- Sole proprietor, partnership, C-Corporation, S-Corporation, or cooperative structure
These tools help ag producers manage taxable income to accelerate income to fill up a lower tax bracket or defer income to future years where their tax bracket might not be so high. Avoiding a spike in your taxable income can save literally thousands of dollars by carefully considering issues such as income tax bracket, capital gains, self-employment tax, net investment income tax, additional Medicare tax, or alternative minimum tax.
Ag producers can pay themselves using commodity wages or gifts of commodities. This saves the family income or self-employment tax liabilities. In both instances the commodity must be formally retitled and sold separately from the farm’s commodities. You can document the transaction with a worksheet stating the date, quantity, and value of the commodity on the date it is transferred. This simple tool could be used more often.
Retirement plan options
Producers can also pay themselves through retirement plans and defer income taxes. Options include a traditional IRA, Roth IRA, Simplified Employee Pension Plan (SEP IRA), Simple IRA, 401k, defined benefit pension, or cash balance plans.
A number of the ag producers I work with use SEP IRA. This plan allows you to contribute up to $55,000 (20 percent of Schedule F self-employment income or 25 percent of employee wages). Contributions are deductible, and the percentage must be identical for all employees. New accounts must be set up and contributions made by the March 1 or April 15 tax return due date. This option provides greater contributions than IRAs and no reporting requirements. One disadvantage is that the employer must fund it 100 percent.
How we can help
Many ag producers have high net worth, but are illiquid because the majority of that net worth is tied to land values. If the family goal for that legacy asset called land is to pass it on to the next generation, it may never be sold. That’s why annual tax planning and financial planning are critical.
At tax planning time, farm families and their advisors should have a financial plan that maps out the future so they can think about some of the unknowns. You will be able to answer questions about how much you should have in retirement accounts or when to take Social Security. You can have a discussion about how much your business is worth and the possibilities of selling it. You will find some comfort in understanding how much of your assets can eventually be gifted to your children and grandchildren.
CLA’s agriculture industry professionals can help you understand the many options you have to pay yourself, fund your operations, and prepare for retirement. Tax planning can help keep your businesses healthy and your farm family prepared for the eventual transition to retirement.