By: Chris Bruynis, Assistant Professor/Extension Educator, OSU Extension Ross County
Harvest is well underway, and even with the lower yields, farmers are starting to look at minimizing their tax liability for 2012. Farmers and their tax accountants are fully aware of the strategies and tools available to them, especially if they are using a cash accounting method. Farmers have historically delayed the sale of crops into the next calendar year and purchased inputs for the next year’s crop. In the past several years there have also been IRS policies that encouraged investment in equipment and buildings. Section 179 and Bonus Depreciation are the most common ones used by farmers.
The Section 179 tax provision allows businesses to deduct the full amount of the purchase price of equipment (up to certain limits). It can be elected for either new or used equipment purchased in fiscal calendar year of the business. In 2012, the deduction amount is $139,000 but is slated to be reduced to $25,000 in 2013. Farmers can elect to use all or part of the deduction amount. An example would be that a farmer purchases new equipment for $100,000 and used equipment for $75,000 in 2012. She can deduct the $75,000 on the used equipment and $64,000 on the new equipment for a total of $139,000 using Section 179. The $36,000 remaining value of the new equipment would then be eligible for bonus depreciation or be placed on the regular depreciation schedule. Section 179 deductions are limited to the amount of net operating income generated by the farm and cannot be used to create a net operating loss.
Bonus depreciation has been a more recent tax law and also geared to encourage investment in equipment and buildings. For 2012 the bonus depreciation rate is 50% of the purchase price and can only be applied to new items. Bonus depreciation is currently slated to disappear in 2013. An example would be that a farmer purchased a new multi-purpose building for equipment storage and the farm shop for $120,000. He can use the bonus depreciation to deduct 50% or $60,000 of the purchase price on his 2012 taxes. Bonus depreciation can be used regardless of net operating income even if it results in a net operating loss.
Typically, Section 179 rules should be applied first and then bonus depreciation rules. The exception to this would be if the farm has no net operating income resulting in the farm being ineligible to use Section 179.
While using these tax tools might be a good strategy to lower taxes this year, farmers and their tax accountants need to be careful not to create future tax liability problems. With Section 179 slated to return to $25,000 in 2013 and bonus depreciation being phased out, these tools will not have the same tax management ability as they currently do. Farmers and their tax preparers need to think strategically about future tax management. The goal should never be to eliminate income taxes but to have net operating income that keeps the farmer in the lowest possible tax bracket long term. This might be the year not to fully utilize Section 179 and bonus deprecation, but to leave more asset value to depreciate with more traditional depreciation methods for future years. This strategy does result in increased taxes this year but could be beneficial in keeping farmers out of higher tax brackets in the future. Tax rates, in my opinion, are unlikely to go down, regardless of what the presidential candidates are promising.