Tips to Make Tax Planning Easier
We recently interviewed Sarah Meyers, a farm accounting officer at AgChoice. Now that the weather has turned cooler, fall season is in full swing and harvest is starting to finish up. Tax planning might be on your mind as we approach the end of 2021. This is an important process for many individuals in agricultural businesses, helping them make informed decisions and understand their tax positions. Sarah will talk about tax planning and how to make to process easier. Below you will find the link to the full podcast:
Why is tax planning important and something that farmers should make time for this time of year?
Tax planning is defined as employing effective tax planning strategies. The art of reducing or eliminating tax liability, we refer to as managing tax liability. There are plenty of areas that we as farmers have the opportunity to work at and to plan around, but they require our action before year end. It’s never too early to start thinking about managing your taxes for year end and minimizing the hit to your income.
A lot of times, we prepare our tax return at the end of the year. Around February or March, we head to our accountant, and they pull the numbers The accountant says, "Had you talked to us in October, November, or December timeframe, we could have helped you plan around." That's why it's important to have the conversation with your accountant sometime before year end to look at some of your options.
As we get caught up in that hustle and bustle of fall and harvest season, you have all this income coming in at the end of the year. Sometimes you get caught up in holiday season with Thanksgiving and Christmas, and you forget that all this income has come in and you have not managed the expense side of it. Then you're at year end and you're kind of stuck with whatever your profit margin is for the calendar year.
As farmers, we are often paying for inputs for the next crop this time of the year, and we're also looking toward some business strategies that could take our business to the next level in the following year. One of the things we want to do is look at where we're going and know how we can get there. If there are ways to manage that tax liability, there may be decisions that we want to accelerate, and there may be decisions that we want to hold off on. In terms of accelerating income, maybe we're going to sell some grain instead of store it. Maybe we want to sell the grain on a deferred contract so that we're no longer holding the crop from a shrinkage standpoint, but the income won't come in until the new year.
It may be beneficial to look at some of our IRAs. Do we have some traditional IRAs that we want to roll into a Roth because maybe we have less income this year than we do in other years and we're in a lower tax bracket? It would make sense to go ahead and pay the tax on the traditional IRA and roll it into a Roth so that now it can grow tax free.
What are your tips for helping to make tax planning easier, both for the farmer and farm accountant?
We talk about tax planning, and to be ready for tax planning, you've got to do a little bit of work ahead of time. You've got to have your books in order before you can have that meeting. Having your QuickBooks up to date and your records of income and expenses up to date, is important for when you sit down and have that conversation with your accountant. You have to know where you stand at today.
The other aspect that you have to look at is knowing the projection of remaining income and expenses to year end. One of the easiest things that we can get wrapped up in as farmers toward the end of the year, is thinking that the number in our checkbook is what we're taxed on. We have to know what expenses will change our tax position. If we are taking extra money out for a year end trip, that may not be tax deductible. You’ve got to know what expenses and income you're planning for the rest of the year, kind of like a budget.
You also want to have an idea of what your capital expenditures were for the year and what items were bought and sold that weren't your normal operating expenses. Did we buy livestock? Did we buy a tractor? Did we trade a tractor? Having those specific invoices ready to share with your accountants is important, because those things will also affect your tax position. They may not have affected the checkbook drastically, especially if you financed it, but what you can deduct and the taxability of your trade will go into play as to what your taxable income is.
Make sure you have those invoices, you have those records of what was bought and sold. If you have livestock on hand, especially livestock that you're buying to resell and holding as inventory, those numbers can play a big difference in what your income is at year end, different from what your checkbook would show.
Each year is always a bit different. Are there any specific items that farmers should be aware of from 2021 and how they may impact taxes and tax planning?
So far 2021 has felt like a year of unknowns. It seems like there's been a lot of chitter chatter in Congress about changes to tax code. There's been some proposals put out there and then they die. Then there's other things that get talked about, but never get proposed. Farmers in general are saying, what's going to change? We're still just all sitting out here, waiting to know if anything is going to change for 2021. As of right now, we can only plan with what we know. At this time there's not a lot of major tax law changes.
One of the things that I am seeing as I'm having conversations with my farmers is the rising cost of inputs. I'm talking crop inputs and feed on dairies. Feed costs are affected. One of the challenges this year is how much do I prepay? Fertilizer cost is probably one of the biggest things right now that can feel almost like a scare tactic, because the cost of fertilizer is jumping so rapidly. Folks are concerned that they need to buy my inputs now, or they won't have them next spring.
We have to be careful multiple different ways. One, do we have the cash flow to be able to buy those costs? And two, do I want those expenses this year, or would we better off to have some of those expenses next year? As I'm talking with some of my grain farmers, we're looking at how much do we sell this year, how much input do we buy for next year, and what inputs do we buy? Typically, the big things we buy this time of the year is seed. Farmers are looking at ordering seed for next year and paying it up front, so they get the best discount possible.
This year, the other aspect that is kind of rearing its ugly head is fertilizer cost. The big question is, can I take delivery of it and how do we manage that side of it? It's been this trickle-down effect of needing other aspects, too. As you're out there planning this year and thinking about what you're going to do for the new year, I would say to take some time to think about what your crop rotations look like. Are you going to stick with the same plan that you thought you were going to, given the changes in cost that we're seeing?
If you have livestock, can you reroute some of your forage ground into something else for grain? You could possibly rotate in a different crop that may not take as much fertilizer or nitrogen as corn would historically. Those are just some things that we're looking at. Even if you feel like you’re going to prepay a lot, you’re going to have a lot of costs that you will incur for 2022, and you’re probably not going to show much profit, it's still important to sit down and look at those tax projections with your accountant.
One of the things that we often fall into is thinking that we don't need to tax plan because it's a down year. That's usually where we have the most opportunity. If it is a down year, we need to look at our balance sheets and our inventories. Is there a way to accelerate some income into this year so that we can avoid having too much income next year? There may be opportunities, like I talked about with traditional IRAs and Roth IRAs, to roll them over and get some tax benefit there. It's important to look at where your operation and your business is today, where it's going, where you want it to go, and how you can best get there from tax management strategies, cash flow management strategies, and overall business planning.
As we wrap up, is there anything else you would like to share with our listeners?
Once you have a plan in place, it's important to stick with it and revisit it. All too often, we do tax planning, and we get busy in our operations, and we don't revisit it in December. Then when we get into mid-January, we realize that we should have looked over it. It’s also important to keep your eyes and ears attune to what's happening in Congress. There may be some changes coming. We often see toward the end of the year that there's some things that come out that may affect things. Keep attuned, stay in touch with your accountants as you go through year end, and educate yourself in the process.
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