by David Marrison, OSU Extension Educator
As winter approaches, it is a good time for Ohio farmers to grab a cup of coffee and start to gather their income and expenses records to determine their cost of production and profitability from 2011. It is also the time to take a peak at their potential income tax liability for the year. This article addresses some of the questions which our Ohio AG Manager team has received with regards to income taxes.
I just signed a lease with an oil company to give them the rights to drill into the Marcellus Shale formation. Will I owe any taxes on this money?
Chuckle, Chuckle-Yes! Lease payments received for the right to drill are subject to ordinary income taxes. A reminder the higher the lease payment, the higher the tax bracket a landowner will be subject. As a general rule, you will need to set aside 35-45% of the payment for federal and state taxes. When the well is drilled, the owner will begin receiving royalty payments which will once again be subject to ordinary income taxes after depletion is taken.
With potential for strong incomes from crop production this year, what are some strategies farmers can use to reduce their potential tax burden?
Now is time for farmers to take a look at their records to examine potential income tax liability. Remember, that paying taxes is not a bad thing! By paying self-employment tax, the farmer is paying into social security which is the primary source of retirement income for many farmers. That said, farmers can use a variety of methods to reduce their liability. This may include using I.R.C. § 179 expensing and/or bonus depreciation, purchasing 2012 inputs in advance, or utilizing Farm Income Averaging to borrow unused tax brackets from the 3 prior years. Farmers can also postpone sales of raised commodities or use deferred-payment contracts to delay receipts into 2012.
Farm input costs are projected to be higher next year, should farmers consider purchasing some of those inputs this year to save money and offset tax levels?
Every farm’s tax obligations are unique; however the pre-purchasing of inputs is one way to reduce your tax liability for the current year. Remember that your deduction may be limited to 50% of your other deductible farm expenses for the year. Any prepayment of livestock feed must also meet specific business purpose criteria and must not cause a material distortion of income.
What is bonus depreciation, how can farmers use it for tax purposes, and how is it scheduled to change next year?
Over the past decade, Congress has repeatedly allowed faster depreciation of capital assets to stimulate business investment by providing a “bonus” depreciation allowance in the year the asset is purchased. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the depreciation bonus for 2011 and 2012 to encourage new equipment purchasing. The additional first-year depreciation rules allow farmers to deduct on their 2011 income tax returns 100% of the cost of qualifying assets purchased in 2011 and 50% of the cost of qualifying assets in 2012.
How can farmers use Section 179 deductions and how is that tax strategy scheduled to change in 2012?
I.R.C. § 179 expensing allows farmers to elect to deduct part or all of the cost of qualifying farm assets in the year they are placed in service. The deduction is limited to the taxpayer’s income from all businesses and is also limited to a set dollar amount that varies by tax year. Under current law, the dollar limit is $500,000 for 2011, $125,000 in 2012, and $25,000 in 2013 and beyond. New and used equipment is eligible for this deduction.
What other changes are known or projected for next year, and how might farmers prepare for or react to those?
Farmers purchasing depreciable items should take notice now of the reductions which may occur in 2012. The reduction of the I.R.C. § 179 expensing will drop from $500,000 in 2011 to $125,000 in 2012 and then $25,000 per year thereafter. In addition, the bonus depreciation is scheduled to drop to 50% of the purchase price of eligible assets in 2012. So if the purchase of capital assets is in your farm’s business plan, now is the time to consider such a purchase. A word of caution, don’t buy “new paint” or “new steel” without first doing a comprehensive cost analysis.
I am a new farmer, are there any special tax deductions that I can take?
For 2011, you can deduct up to $5,000 of your business start up costs paid or incurred after October 22, 2004. The increased limit of $10,000 for start-up costs was only allowed in 2010.
Are there any Ohio tax issues farmers should keep in mind in 2011 and 2012?
One of the major tax issues for farmers to be aware of is not an income tax change but rather the increases which are being seen across Ohio for the CAUV (Current Agricultural Use Valuation) property tax program. Every three years, each county in Ohio is required to complete a triennial update on property values. This also required the re-calculation of the CAUV values. CAUV values are calculated for each soil type in Ohio (approximately 3500 soils) by a formula that is based on five factors. The factors used in the calculation are based on three crops: wheat, corn and soybeans. Also considered is the cropping pattern, production costs and the capitalization rate. These CAUV rates have increased significantly since 2008. These increases could cause landowners to increase the rental rates to the tenant farmers. Farmers should pay particular attention to their tax statements over the next 3 years.
What are some good sources of tax advice and information for farmers with questions?
A great location to find agricultural tax advice is through the new agricultural tax web site at www.RuralTax.org. This website provides with a source for agriculturally related income and self-employment tax information that is current and easy to understand. Producers should also watch for tax articles on OSU Extension’s Ohio Ag Manager web site located at http://ohioagmanager.osu.edu. Producers who prepare their own taxes should plan on attending OSU Extension’s Agricultural Tax Issues Update which will be held in 9 locations across Ohio on Monday, December 12, 2011. More information about this update can be found at: http://incometaxschools.osu.edu/. And last but not least, the Farmer’s Tax Guide is an excellent resource and it can be found at: http://www.irs.gov/pub/irs-pdf/p225.pdf.