October is a good time to look for strategies, especially with the recent tax-code changes
Typically, we think of the importance of tax planning when things are going very well for the industry because taxable income runs higher and managing the taxation of that income is an important consideration.
However, income tax planning is still important in economically difficult years. This year is a good example. While many segments of ag production have lost money during the year, it is still possible to have taxable income and a tax liability that could shock farmers, ranchers and cattle feeders if they are not prepared.
We recommend that agricultural producers start planning for projected taxable income at least two months before year-end. With all the changes to the tax code this year, it makes sense to start earlier than that. October may be the month to begin the process. This will provide an adequate timeframe to implement strategies to manage taxable income.
Managing tax liability
If planning indicates an upcoming tax liability, there are a number of options to consider in managing that liability. First, rather than a total tax-aversion strategy, it is usually wise to load up lower tax brackets with taxable income. The next level of tax planning for income beyond the lower rates involves the deferral of income and acceleration of expenses.
Contracting and prepaying inputs to accelerate expense is common and deferred payment contracts on sold goods are also used. These do, however, introduce additional business risks, such as third-party risk, market risk, financial risk and even interest rate risk, which must be balanced against the anticipated tax benefit through planning. Accelerated depreciation is also a significant tool to use when managing taxable income.
Longer-term strategies
Beyond these annual tax-planning strategies, there are longer-term strategies as well. One is the creation of multiple entities for various components of the overall business with varying year-ends. A simple example of a farming entity combined with a land ownership entity allows for some deferral and acceleration strategies among the entities but keeps the total dollars involved within the ownership umbrella. This can provide significant benefits to the owners, not just from income taxes but also for business risk and succession planning.
Is it wise, however, to continue growing deferrals each year? This is a complex question with several variables and should be addressed from an economical perspective rather than a philosophical one. If your business has generated enough income to fill lower tax brackets and create a large deferral even with wise annual planning strategies, perhaps congratulations are first in order. Beyond that, there are some even more sophisticated strategies available to manage those deferrals, which allows the continuation of the deferral benefits while not requiring continued operational risk, as in the case of retirement or business downsizing.
Nebraska insight
Last year, I was meeting with a ranch family in central Nebraska. Marvin is the second generation, and he is about 60 years old with two sons working on the ranch. This was the first year that he turned over the financial decisions for the ranch to his two sons. They had been involved in the past, but this year they were making the final decision.
We were discussing tax planning for the coming year, and one of the sons asked why we keep “kicking the can down the road” and wouldn’t it be better to “just bite the bullet and pay the tax?” Especially considering that some of the tax rates are lower due to the recent tax reform. I appreciated the question and was prepared to answer when Marvin piped up and said, “The reason our ranch is successful is because we stay focused on managing dollars. If we give more dollars to the government, that is less dollars we will have when times get really tough.”
Well said, Marvin.
Editor’s note: Doug Claussen has more than 20 years experience with his agriculture and accounting expertise at K·Coe Isom as he helps ag business owners with financial, operational and tax challenges. He works with agribusinesses involved in beef production, dairy operations, grain production and marketing. Contact him at [email protected].
