Michigan Dairy Review
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2008 Dairy Survey

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CornPicker for Silage Hybrids

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2009 Income Tax Planning

Larry Borton
Dept. of Agricultural, Food & Resource Economics

If your tax goal is to owe zero income and payroll taxes, then this year’s low milk prices make it easy. But if your objective is to get income through the tax system with paying the lowest taxes, then planning may be more challenging. First are some facts about this year’s taxes.

•   Tax rates are lower this year and next year and scheduled to increase in 2011. 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) 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. 
•    Michigan income tax rate remains at 4.35% for 2009. 
•    A 1-year requirement exists to treat new farm equipment and machinery as five-year property rather than its normal 7-year life. This only applies to new (original use) items and does not include grain bins, fences, cotton gins or land improvements. By electing to use ADS (Alternate Depreciation System) the 7-year property can be depreciated over 10 years but all farm machinery and equipment, both new and used, placed into service in 2009 would then need to be depreciated over 10 years. 
•   The 50% bonus depreciation was extended for another year and covers virtually all new farm property placed into service in 2009. All new property within a class (like 5-year, 7-year, 10-year, 15-year or 20-year) must be treated the same. This is mandatory unless the taxpayer elects out of this provision. Anyone required to use ADS (most fruit farmers) is not eligible for this provision.    
•   The direct expensing remains at $250,000 for 2009 with phase out beginning at $800,000 of qualified property placed into service. 
•   For 2009 and 2010 an educational credit increased to a maximum of $2,500 for the first 4 years of study (it was previously $1,800 for the first 2 years). 
•   First time home buyers credit (refundable) up to $8,000 if the house is closed by November 30, 2009. 
•   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. 

Dairy farmers may want to minimize deductions and increase income for this year if their taxable income is low or negative. Depreciation can be reduced but only for items placed into service in 2009. This would include electing out of 50% bonus depreciation. Items previously placed into service already have a method that cannot be changed now. Prepaid expenses may still be used but fewer farmers will use them this year. 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 3 years, then income averaging still might use these brackets if unable to use them this year.

Another way to increase 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) also may 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.  

A further complication may arise if milk income was deferred from the end of 2008 to the beginning of 2009. 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.

Because 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. Although our goal is to use up our lower brackets, there may not be enough income to use them and there may be a loss from the farm operation. 

Carrying Back Net Operating Losses
Farmers with a Net Operating Loss (NOL) may be able to carry back the loss 5 years or 2 years and essentially get a refund of income taxes paid in prior years. The reason for doing this is to make a little more cash available. The concept is to take this year’s business or farm losses to years when income taxes were paid and offset taxable income in those years to get tax refunds. The calculations to get the refund are quite complex, but we can get a general knowledge for it without getting lost in computations. 

A NOL can be claimed by an individual, C Corporation, partner, LLC member or S Corporation shareholder. A taxpayer must have negative taxable income but only business losses can be carried back or forward. So if a spouse’s wage income, for example, makes taxable income positive, then the taxpayer does not have a NOL even though the farm or business had a loss. 

Some items are not part of a NOL and will reduce or eliminate it. These include dependent and personal exemptions ($3,650 per person in 2009), some non-business deductions, and excess capital losses (like investments). Another item that reduces the NOL is the Domestic Production Activities Deduction (DPAD) which many farmers have used and can be quite large for members of cooperatives. 

When income is carried back to earlier years, the loss is absorbed by the Modified Adjusted Gross Income (MAGI) from that year. The MAGI is the taxpayer’s adjusted gross income plus personal and dependent exemptions plus the DPAD and some other items. Any loss greater than the amount absorbed is carried over to the succeeding year (or years) until the loss is used up. A NOL can be carried forward up to 20 years. 

For example, a sole proprietorship has a NOL. The taxpayer is married, filing jointly with no children. Because of low milk prices and high input costs, their taxable income for 2009 is negative $60,000. When personal exemptions (2 times $3,650 = $7,300) and the standard deduction ($11,400) are added back, then the NOL is -$41,300 (-60,000 + 7,300 + 11,400). To illustrate how the carry back works, the table below shows an adjusted gross income and taxable income for 2007 and 2008. Using these to calculate the taxes refunded:

Tax figures

Thus, the total federal taxes saved were $2,653 (1,250 + 1,403). In 2007 the $41,000 NOL carried back from 2009 absorbed all $20,300 of MAGI and reduced taxes by $1,250. In 2008 the remaining $21,000 NOL carried over from 2007 was completely absorbed and left $11,100 of taxable income which reduced income taxes to $1,110 (using the 10% tax bracket). This resulted in $1,403 taxes saved for year 2008. All of the NOL was absorbed and $2,653 federal taxes can be refunded.

Carrying back NOLs will not reduce self-employment taxes. Your social security and Medicare payments do not change from the amounts paid or due. 

A NOL cannot be made larger by using section 179 direct expensing on depreciable items placed into service. One of the limits on direct expensing is that business income must be positive and if it was positive, there probably would not be a NOL. However, if eligible for using 50% bonus depreciation, it doesn’t have the business income limit so that can make a NOL larger. 

Some tax brackets in the past have been quite low. The federal long term capital gain rates have been 0%, 5% and 15% while the ordinary rates have been 10%, 15%, 25% and higher. If you absorb taxable income from last year at 0%, that doesn’t put any cash in your refund although it may be necessary in order to use tax brackets that will increase your refund. 

If more than one business has a NOL, then calculations become more complex. If one business is a farm and the other business is not, they both can be carried back under slightly different rules. Also, prior income averaging or the Alternative Minimum Tax may complicate the calculations for some. 

A NOL may also be carried back to past years or forward to future years for Michigan income taxes.  An allowed NOL is also a deduction from household income in those years and may be used to increase the amount of homestead property tax credit and farmland preservation tax credit. 

Generally, income and self-employment taxes are less when income is stable over time and the lower tax brackets are used up every year (10% and 15%). Carrying back NOLs is one way to get some cash if income taxes were paid in previous years. Given up in this process is that the NOL gets absorbed faster than the benefit from it. Your tax practitioner’s computer software should help with the complex calculations to see if there is a benefit.  If a taxpayer expects a NOL, tax planning and action before January may increase the amount of refund. 

Contact for questions:  Larry Borton, Michigan State University Telfarm, 517-355-4700, bortonL@msu.edu.



Oct Issue

Cow Comfort
Gauging cow comfort at the new KBS Dairy.

Maximizing Intake of Corn Silage Pt2
Part 2 of how corn silage affect energy intake and animal performance.

Management "Tips"
Continuing with the series of "tips" aimed at assisting dairy producers especially in the current harsh economic climate.

High-fertility, High-producing Cows
There is more to milk production and reproductive performance than just genetics.

2009 Income Tax Planning
Challenges in planning to achieve 2009 tax goals.

Spread Winter Manure with Great Caution
Inherent risks of variable winter weather conditions.

Feed Inventory Management
The importance of managing farm inventories of feeds.

Is 3X Milking for You?
Pros and cons of 3X milking.

Farm Visitors' Policy
Curbing potential routes disease can enter farm operations.