By David Bekedam
It’s never too early to start planning the management of your 2011 taxable income. In December of 2010, Congress passed a two year extension of the Bush-Era tax cuts giving guidance for 2011 and 2012 and providing an opportunity to take advantage of lower tax brackets and favorable capital gains rates.
Hopefully your 2010 tax returns were completed without any surprises. While 2010 was a much better year income wise than 2009, many dairymen used their free cash flow to catch up on payables and pay down bank debt. With good demand worldwide for dairy products, prices are expected to stay strong this year. Managing your taxable income will be crucial.
Farmers – a privileged group
In regards to the tax code, farmers are a privileged group granted the unique ability to legally prepay expenses and defer income. Because of this, many farmers at the end of the year, even in bad years, may find themselves with an unexpected large amount of taxable income to deal with. Over the next couple of years, managing these deferrals will become increasingly important. This is not only due to the fact that tax rates are expected to increase in 2013, but also due to the availability of credit, i.e. prepay and deferral loans.
So what can we do to manage taxable income to keep deferrals from snow balling? Let’s start with a discussion about long term capital gains. Many dairymen choose not to pay any tax at the end of the year. Therefore, they prepay or defer enough to get taxable income to zero. Long term capital gains rates, the rate you pay on the majority of your cull cow income, is set at 15% for the next two years, scheduled to go to 20% in 2013. Deferring out of this income not only precludes you from taking advantage of this low rate, it also consumes funds that could be used in the following year to pay down income that could be taxed at effective rates above 40%.
Many of you may have large net operating loss carry forwards going into 2011. It may be to your advantage to make use of these as well. Tax rates on Self Employment income have been lowered for 2011. The employee portion of the OASDI tax has gone from 6.2% to 4.2% (employer portion remains at 6.2%). This means on the first $106,800 of income you will pay 10.4% instead of 12.4%. Keep in mind the Medicare portion of the tax remains at 2.9% on all S/E income. Depending on the amount of your NOL carry forwards, you may be able to offset the rest of your taxable income by using them. Do consult your tax advisor on using NOL’s as there may be limitations on their use resulting from the new farm bill and for state purposes such as in California.
Bonus depreciation increased
Last, but definitely not least, the 2010 Tax Relief Act increases the 50% bonus depreciation to 100% for qualifying new fixed asset purchases in 2011. For assets purchased and placed in service from January 1, 2012 through Dec. 31, 2013, the bonus amount reverts back to 50%. Bonus depreciation provides a couple advantages over Section 179 expensing. There are no investment or income limitations using bonus depreciation. Section 179 expensing for 2011 is limited in amount to $500,000 and begins phasing out when investments exceed $2,000,000. In 2012, these amounts adjust to $125,000 and phase outs begin when investments exceed $500,000. Bonus depreciation, as opposed to Section 179, can also be used to create a loss if needed to offset income from other sources. Allowable Section 179 expensing amounts for states do not always conform to federal and will vary from state to state.
Cash flow impact
When taking advantage of bonus and Section 179 depreciation on new assets, be sure to first consider the necessity of your purchase and how it may affect your cash flow. There are still opportunities to take advantage of favorable financing on equipment purchases. Make certain that your bank concurs with the reasons these purchases are necessary and their effects on free cash flow that might otherwise be used to improve your position with the bank.
While we can all breath a sigh of relief for now that congress has decided to keep tax rates from reverting back to increased amounts, they won’t stay at these levels forever. The extensions are set to expire Jan. 1, 2013, not surprising right at the end of the next presidential election. Use the time given in the next two years wisely.
Talk to banker and CPA
Take advantage of lower rates by budgeting and managing to pay tax at lower rates. Make sure your bank is willing to advance the funds necessary at the end of the year to allow you to manage your taxable income and consult with your CPA for tax planning to avoid any unpleasant surprises that may have escaped consideration.
■ David Bekedam, CPA, senior manager, Moore Stephens Wurth Frazer and Torbet, LLP, in Visalia, Calif. Contact him by e-mail at: email@example.com or call, 559-732-4135 Ext. 120.