As the end of the year closes in, priorities shift from outside work to inside work, including year-end income tax planning. There are several things to keep in mind this year, including new laws that were passed in late 2010 and 2011 that impact farm income tax planning strategies.
Reduced Self-Employment Tax:
Early in the year, employers learned about a new law that reduced the employee portion of social security from 6.2% to 4.2% for 2011. This resulted in withholding less social security from employee paychecks. However, what is not as commonly known is that the same law also reduced the self-employment tax rate for self-employed individuals, including farmers, by 2%. Self-employment tax is calculated on Schedule SE of a self-employed individual's federal income tax return.
100% Bonus Depreciation
Bonus depreciation is a powerful tax planning tool. Enacted to encourage taxpayers to purchase additional equipment, bonus depreciation is a method of accelerated depreciation which allows farmers and other business owners to take an additional deduction during the year in which new property is placed in service. The bonus depreciation rate for 2011 is 100% which means qualified assets that are acquired and placed in service in 2011 are eligible to be completely expensed in 2011.
Bonus depreciation is allowed on newly acquired property with a recovery period of 20 years or less, including farm equipment, single purpose agricultural structures, and farm buildings. Therefore, in 2011, it is possible to expense a new farm building in its entirety. To be eligible for bonus depreciation, the farm building must be newly constructed. An existing building included with a new land purchase is not a new building for purposes of bonus depreciation because it is not newly constructed. In addition, the newly constructed building must be used 100% for farming purposes. Even a small percentage of usage for a purpose other than farming will deem the building ineligible for bonus depreciation.
Bonus depreciation is mandatory unless the taxpayer files a valid election to opt out with the taxpayer's timely filed income tax return. Unless new legislation is passed, the bonus depreciation rate will drop back to 50% for 2012.
Section 179 Deduction
The Section 179 deduction is a common tax planning tool utilized by farmers. Section 179 is a provision in the tax code that allows farmers to expense the cost qualified property placed in service during the tax year. Designed as a small business benefit, Section 179 puts a limit on how much a business owner can spend on equipment and other qualified property during the tax year and still utilize the deduction. In 2011, Section 179 allows farmers to expense up to $500,000 as long as they purchase less than $2,000,000 in equipment and other qualifying assets. For every dollar spent over $2,000,000, the Section 179 deduction is reduced by one dollar. Unlike bonus depreciation, Section 179 can be utilized for new and used assets placed in service during the tax year. In addition to the traditional categories of property eligible for Section 179 treatment, "qualified real property" which includes leasehold improvements was added for 2010 and 2011.
Under current legislation, the maximum deduction under Section 179 will decrease to $125,000(adjusted for inflation) for 2012. It is very possible that future legislation will extend the current $500,000 deduction going into 2012; however, that is speculation at this point and cannot be counted on for tax planning purposes.
While most farmers are familiar with Section 179, many do not know that they can revoke a Section 179 election for a prior tax year that is still open for amendment (typically the past three years). While most tax planning strategies are focused on future tax years, the ability to revoke a prior Section 179 election allows taxpayers to tax plan in reverse. Under current tax law, this revocation option is only allowed through 2012.
Thoughtful tax planning can result in significant tax savings for farmers. Information on additional agricultural income tax topics can be found in the 2011 Farmers Tax Guide, IRS Publication 225 http://www.irs.gov/pub/irs-pdf/p225.pdf.© 2013 Varnum LLP