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2010 Income Tax Planning

Larry Borton
Dept. of Agricultural, Food & Resource Economics

Tax planning can help retain more income through the tax system by paying the lowest and correct amount of taxes. Congress has many tax items that may be decided before we have to file for 2010, but we will look at the current tax rules to use in planning this year. 

•  Farmers do not have to file estimated income taxes if they file and pay by March 1, 2011. A farmer is defined in this part of the tax code as a taxpayer with at least 2/3 of gross income (not net) from farming in either 2009 or 2010. 
•  Tax rates are lower this year and scheduled to increase next year. The 10% tax bracket will disappear after 2010 so the lowest bracket will be 15%. The highest bracket will increase from 35% to 39.6% for ordinary income. The long term capital gains rate (used for raised, cull cows that are sold, for example) increases from 0% or 15% to 10% or 20%. These will happen without Congress changing any laws. 
•  Social Security and Medicare remain at 15.3% on the first $106,800 of earned income and 2.9% for higher income. Farmers have an optional method to pay Self-Employment (SE) tax even if income is low or negative. Work credits can be earned toward retirement or disability eligibility. Often, the SE tax paid in this option may be refunded as Earned Income Credit.
•  The Domestic Production Activity Deduction (DPAD) increased to 9% of Qualified Production Activities Income. It has limitations including not more than 50% of W-2 wages paid by the farm employer. A cooperative may pass along a DPAD to a member-farmer even if the farmer has no hired labor wages. This cooperative DPAD may cause confusion because it is a deduction based on what we formerly called milk sales. Now the milk sales are “per unit retains paid in money” (PURPIM). Most farms will actually be receiving a 1099 statement noting the PURPIM which are reported as income on a different line from milk sales on the Schedule F of Form 1040. Treating this income as retains is proper for tax reporting but it can be treated as milk sales for business analysis purposes.  
•  Michigan income tax rate remains at 4.35% for 2010  
•  The direct expensing of depreciable items stays at $250,000 for 2010 with phaseout beginning at $800,000 of qualified property placed into service. 
•  For 2009 and 2010 the American Opportunity Tax Credit for post-secondary education allows a maximum of $2,500 per year per student for the first four years of study (the Hope Credit was previously $1,800 per year for the first two years). Up to 40% of this is refundable which means you can get a refund even if you don’t owe any income tax. The Lifetime Learning Credit of 20% of up to $10,000 expenses or a maximum credit of  $2,000 is still available if not qualified for the American Opportunity or Hope Credits. 
•  First-time homebuyer’s credit (refundable) of up to $8,000 if the house was purchased by April 30, 2010 and closed by September 30, 2010. Long-time resident homebuyers with 5 consecutive years out of 8 in their principal residence could be treated as first-time homebuyers with up to $6,500 in credit. 
•  A maximum of $1,500 credit for qualifying energy property purchased for your principal residence. It’s calculated as 30% of the purchase price for items that qualify. 
•  An alternative energy credit of 30% of wind, solar, and other property is available through 2016.
•  An employment tax deduction is available for employers that hire previously unemployed workers. It exempts the 6.2% employer’s share of social security from March 19 to December 31, 2010 of qualifying workers hired after February 3, 2010. Workers should fill out and sign Form W-11 if they were unemployed for the 60-day period (not more than 40 hours of work) prior to employment. 
•  A new general business tax credit, New Hire Retention Credit, for 2011 income tax returns equal to 6.2% of wages paid to each qualified employee who is retained for at least 52 weeks, not to exceed $1,000 per qualified employee. 

Improving Your Bottomline
Farmers may want to minimize deductions and increase income for this year if their taxable income is low or negative. Depreciation can be reduced by choosing a slower recovery method but only for items placed into service in 2010. Items previously placed into service already have a method that cannot be changed now. If a taxpayer has the 0% long term capital gains bracket available (for taxable income below the 25% ordinary income tax bracket), it makes sense to use this bracket. If profits are made in the next three years, then income averaging still might use these brackets if unable to use them this year.

Another way to increase personal income is to convert a traditional IRA, SEP-IRA or a SIMPLE IRA to a Roth IRA. As of 2008 an employer-sponsored retirement plan like a 401(k) or 403(b) may also be directly converted to a Roth IRA.  These were usually not taxed when contributions were made and will be taxed when distributions are made. The amounts converted count as taxable income in the conversion year but if the tax rate is zero, then there will be no tax. Future qualified distributions from a Roth IRA will not be taxable income. Converting may be done by a farmer or even a spouse if married, filing jointly. Some farmers may want to increase expenses or defer income. Prepaying expenses reduces net income and may reduce taxes but there must be a business reason for it like getting a discount or insuring a supply is available. 

Something to Keep in Mind
A complication may arise if milk income was deferred from the end of one year to the beginning of the next. The IRS has a program to audit dairy farmers to check for this. Any deferral of income from milk sales is being disallowed based on a Minnesota court case where grain delivered to a cooperative was not considered a sale until it was later sold by the cooperative. Since the farmer did not “sell” the grain to the cooperative, no installment sale (or deferral of income) was possible in spite of having a contract in place before delivery of the commodity. This seems consistent with treating milk sales as per unit retains for the DPAD instead of as milk sales. 

If a farmer has a business Net Operating Loss (NOL), then there is an option to carryback the loss to years when income tax was paid in order to get a tax refund. If unable to carry the losses to previous years, then the loss may be carried forward to reduce income tax in future years.

The annual exclusion from gift tax remains at $13,000 per person without any gift tax or without using up the $1 million lifetime exemption. For example, anyone reading this article can mail me a check for $13,000 as a gift and neither of us will have to pay any extra tax for the gift. It is not taxable income to me and not a deductible expense for you. I, however, would need to increase my Michigan Household Income by $13,000 which may affect some of my Michigan tax credits that are determined by household income like the Homestead or Farmland Preservation Credits. 

While there is no estate tax this year, when a death occurs in 2010, the executor (or personal administrator) can increase the basis of property inherited by $1.3 million plus an extra $3.0 million if there is a surviving spouse. Property subsequently sold may be subject to tax on the gains, but that is much less than the estate tax rates of past years and in 2011. 

Next year the familiar rules of getting a step-up in basis (or a step-down) to the fair market value on the date of death will return. However, there is only $1 million of the estate that won’t be subject to estate tax. It’s easy for farms to get above that value. Check your last year’s balance sheet to get an approximation of that fair market value. Please see your legal advisor and/or MSU Extension farm management educator this winter about estate planning for next year.

The current Alternative Minimum Tax exemption amount is $45,000. If Congress does not increase it to about $70,000 for married, filing jointly, then many farmers may become subject to this tax. The Alternative Minimum Tax is a completely separate method to calculate the income tax due. Most software tax programs automatically check to see if it applies.   

The week after the health care bill passed, many phone calls asked what the costs of it will be to a farm operation or business. That is a really tough question about a couple thousand page bill that few had ever read before voting on it. While we can explain specific items in it, regulations to implement the rules are still at the beginning stage of development. Many items do not take effect for several years. More information will become available as regulations are developed. 

Rules mentioned in this article are covered in general to help understand the tax laws. Phaseouts, additional eligibility criteria and timing limits exist for many of these. Congress may take actions over the next few months that change these rules which would require you to make adjustments in your tax plan based on that information. For specific applications be sure to talk to your MSU Extension Educator and/or your tax advisor.  

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