As we head deeper into fall, many ag producers are thinking about tax planning—that is, analyzing your financial situations from a tax perspective.
The purpose of tax planning is often to minimize your tax liability. To maximize your business viability, you should consider a longer-term tax planning strategy that coincides with your business planning goals. Don’t focus just on the dollars of tax you pay or save. Instead, focus on planning in areas where your tax strategies and your business and financial plans work together in the most efficient manner possible. Focus on the rate of tax you pay, not the amount. In other words, pay close attention to the tax bracket you are in over the next several years.
Store grain or sell?
In typical years, grain storage can increase income by giving farmers more marketing options while pushing the tax on the crop revenue into the next year. The key is to consider all costs before making storage decisions:
Will the costs incurred outweigh the increase in price?
There will be additional storage costs.
Will you have to carry a larger debt balance without the crop sales? If so, account for the interest you can expect to pay on that higher balance.
If additional debt is not a concern because you have excess cash reserves, you should also consider the opportunity costs.
Will the basis improve or worsen if you keep the grain? Know what is normal for your area.
Evaluate the hidden costs of storing grain. Generally, you can expect shrinkage and quality deterioration.
Do you have drying costs if the grain is stored?
Consider timing of future labor requirements if you will be hauling your own grain.
Keep and grow calves or sell?
As with storing grain, you can often increase your revenue and marketing flexibility if you retain ownership and grow your calves to a higher weight. If you have excess or adequate feed and facilities, generally your cost of gain will be low, it should pencil out to keep and grow your own calves. Consider the following issues:
Do you have the time and the staffing levels needed?
You’ll have to weigh in the interest expense since you won’t be generating the cash to pay down loans.
Will the basis improve or worsen? Know what is normal for your area.
Evaluate the hidden costs, such as increased repairs and increased risk of death loss.
No matter which strategy you choose, it’s important that you assess and know the risks and the rewards of each option. Additionally, evaluate your risk management strategies to ensure you have adequate price protection if you are carrying commodities to the next tax year.
Farmers and ranchers often pay for seed, feed, fertilizer and other inputs in one year and use the items in the subsequent year. In addition to lowering tax liability, this strategy has many benefits, such as obtaining a lower purchase price and guaranteeing the availability of a specific item. If you are considering this strategy, make sure you consider the following:
Are you really getting a good deal by buying early? Know the price trends and don’t just go by what a dealer may be telling you.
Are you hindering your crop-mix options by buying seed and other inputs early? Make sure you evaluate your chemical use and seed purchases when prepaying so you have the options you need when planting time comes.
Be sure to understand the interest expense you may be paying by buying this fall versus just agreeing to purchase something later and pay for it next summer.
Make sure you are aware of the definitions and guidelines related to prepayment of farm expenses, so you can navigate IRS requirements and properly plan for taxes.
Asset purchases that qualify for the Section 179 deduction are often incorporated into a tax planning strategy. These purchases should be carefully considered because, unlike other strategies, they often have a multi-year impact on cash flow. Large capital purchases are usually financed, so while the asset is expensed for tax purposes in year one, the required cash outlays often extend out five to 10 years. When evaluating this option:
Consider comparing the tax benefit to the additional interest expense associated with the equipment debt as well as interest on any working capital shortages that might arise;
Think about whether the equipment creates improved capacity or reduces associated expenses like fuel and repairs;
Weigh whether you’re getting a good deal on the purchase or whether the terms could improve later. Know the sales cycle for your potential purchases.
Make sure you evaluate the impact of having to possibly make a financed principal payment in a later year and not having the cash flow to pay the taxes. Debt is not a deductible expense. If you depreciated the asset in a prior year and cash flow is tight later, you may be creating a tax consequence in a year when there is no money to pay taxes.
Editor’s note: Dennis Roddy is a Midwest-based agricultural consultant with K·Coe Isom. With more than two decades of experience in ag lending and farm management, as well as real-world farming and ranching experience, he is uniquely qualified to help farmers and ranchers operate profitably. Contact him at firstname.lastname@example.org.