It’s standard practice for farmers, who are cash basis taxpayers, to accelerate expenses at year-end. Paying fertilizer, seed and chemical bills prior to Dec. 31 can create a paper loss and reduce your current year taxable income to near zero or below. The sister practice is to defer income into the following year by holding a portion of your corn and soybean crop to be sold after Jan. 1.
These practices are founded in time value of money theory, which tells us that, all other things constant, a dollar today is more valuable than a dollar to be received one year from today. Or said another way, why pay taxes today when you could pay them next year?
For a growing farmer, this strategy can continue year after year until you stop farming. If you add a few acres and input prices rise each year, you can almost always find enough bills to prepay to virtually eliminate your current year’s taxable income. Unfortunately, upon retiring, a farmer can end up with two years of income (the year deferred and the current year) and no expenses (they were all accelerated into last year).
This year, as we near the Dec. 31end date of the tax year, take a few minutes to have a serious discussion with your tax accountant about whether you really want to prepay or not.
What we know:
- President Obama has been re-elected to a second term on a platform of higher taxes for “millionaires and billionaires.”
- The President’s definition of wealthy may include married couples earning more than $250,000 per year or individuals earning more than $200,000.
- In a good growing year, with adequate rainfall (unlike this year!) it wouldn’t take too many acres to report net earnings in excess of $250,000, assuming commodity prices don’t totally fall of the table.
- The U.S. government is projected to hit its most recent debt ceiling in mid-December or January and Congress has to deal with the so-called “Fiscal Cliff” that takes effect Jan. 1 if not addressed. With a divided legislature, let’s not hold our breath that these important issues will get addressed in a manner that doesn’t involve increased tax rates.
If you think there’s a possibility that tax rates will move higher in the near future, it may make sense to NOT prepay all of your expenses. This will involve paying some income tax for the current tax year. It may require an estimated tax payment at Dec. 31 and another check payable to the I.R.S. on April 15. But consider this: Unless you plan on losing money, your tax bill is assured. While not guaranteed, it’s possible that your choices are paying today at a maximum federal rate of 35% or paying at a future tax rate of who knows what.