As another year draws near to a close, we reflect on things that transpired in 2015 as we begin to plan for a full and prosperous new year. An important element of planning is a forward look at the coming tax season. Here is a brief look at a few opportunities for tax savings to jump start a conversation with your tax professionals.
Income Averaging for Federal Returns
Federal statutes allow farmers to spread a portion of their current year farming income equally over the three previous tax years. This treatment can make sense for any of the following reasons:
- Your current year taxable income places you in a higher marginal tax bracket than prior years. Income earned at the higher rate can be applied retroactively to prior years with lower rates.
- The farm income averaging election has not been utilized in earlier years. The IRS will let you amend prior years’ filings to capture those benefits.
- Starting in 2013, high-income farmers saw an increase from 35 percent to 39.6 percent in the top tier of federal taxes. By averaging income back to 2012, you can take advantage of a 35 percent marginal rate on some of your earnings.
- You anticipate higher income or higher tax rates in the future. Applying income averaging for 2012-2015 sets you up for profitable use of this treatment in future years.
IRS Schedule J captures the farm income averaging calculation. Your tax professionals can help you assess the benefits and provide the proper reporting.
Favorable Tax Treatment for Oregon Farmers
In a special election at the close of its 2013 session, the Oregon legislature granted a tax break for individuals who receive flow-through income from an active trade or business. Such flow-through income typically originates from an S-corporation or a multi-member limited liability company (LLC).
If your Oregon-based farm has already been organized as an S-corporation or a multi-member LLC, then you’ll enjoy lower Oregon tax rates in 2015. If not, you should consider whether the tax benefits offset the incremental effort to restructure your business. Your tax professionals can provide estimates of savings as well as ballpark figures for one-time and recurring costs.
Net Investment Income Tax
In the wake of the Affordable Care Act, Congress authorized the imposition of a 3.8 percent net investment income tax on individuals with significant modified adjusted gross income (AGI). In particular, once a married couple filing jointly reports AGI in excess of $250,000, a 3.8 percent incremental tax applies to all passive income beyond that threshold. Individuals cross the mark at $200,000.
If you are active in your farm business, there are two sources of investment income that can bypass this incremental tax. If you or an LLC in which you hold an interest owns the land and buildings on which the farm operates, then your “self-rental” income will not be subject to the 3.8 percent tax. In like fashion, if you serve as the farm’s creditor, then the interest income earned through this arrangement is not subject to the 3.8 percent tax. In both cases, the word ACTIVE plays a significant role in determining tax treatment. Your tax professionals can review the qualifications and help you assemble appropriate documentation to support your case.
At a minimum, the following actions should be taken:
- Prepare and execute an appropriate rental agreement between the property owner(s) and the farming business. Make sure that all rents align with fair market values.
- Prepare and execute lending agreements to address monies loaned by individuals to the farming business. Use interest rates consistent with other creditors in the marketplace based on the type of loan, the duration, and risk assessment.
- Where possible, incorporate a description of the role the property owner (or lender) plays in the ongoing management of the farm. This documentation strengthens the case for “active” participation.
Favorable Tax Treatments in Effect for 2015 Tax Year
|Amount of Pass-Through Income||New Applicable Tax Rate||Old Rate|
|Less than $250,000||7.00%||9.00%|
|$250,000 – $500,000||7.20%||9.00%|
|$500,000 – $1,000,000||7.60%||9.60%|
|$1,000,000 – $2,500,000||8.00%||9.00%|
|$2,500,000 – $5,000,000||9.00%||9.00%|
|More than $5,000,000||9.90%||9.90%|
We’ve highlighted just a few of the items that should be on your radar as you sit at the planning table with your tax professionals. Please contact us if you’d like to review these opportunities or discuss other options for tax savings.
Meet the Author
Curtis Sawyer, CPA
Aldrich CPAs + Advisors LLP
Curtis Sawyer provides farm accounting, tax compliance, planning, and agribusiness consulting services to his clients in the agriculture industry. He works closely with businesses across several industries with an emphasis in agriculture, farming, cooperatives and food-processing, as well as closely-held businesses and their owners. Curtis also presents on topics including regulatory reform and tax savings... Read more Curtis Sawyer, CPA
- Agribusiness consulting
- Farm accounting
- Closely-held businesses
- Certified Public Accountant
- Strategic tax planning and compliance