Between now and year-end, we work with our farm clients to estimate their farm income and the related tax bill due next March. Most times, this tax planning is fairly accurate and the actual amount of tax owed is what the farmer expected.
However, there are times when the farmer either spends too much on farm inputs or does not collect all of the anticipated income before year-end. In these cases, the amount of farm income comes in much lower than expected. In most other industries, the taxpayer would be stuck with this result. But through the use of deferred payment contracts, farmers can accelerate income recognized from cash proceeds received in 2013 into 2012 and increase income to the desired amount.
How deferred payment contracts work
Deferred payment contracts may be based on a sale of grain in the current year, with payment being received in a subsequent year. Normally, the sale of the grain is taxed when cash is received, but tax laws allow farmers to elect out of the installment method on any of the contracts and accelerate income into the year of sale.
With the uncertainty of the current income tax situation (expiring tax cuts may be extended; Section 179 may be increased retroactively; bonus depreciation might be retained for 2013), these contracts provide flexibility to farmers for 2012 and 2013. To maximize this flexibility, we strongly recommend that farmers have at least two or three contracts that are smaller than normal so they are able to pick and choose which contracts (i.e., which installment sale obligation) to elect out of. The election is on a contract-by-contract basis — you cannot pick and choose a dollar amount.
Here’s an example
Assume Farmer Jones has entered into three deferred payment contracts, all at $7.50 per bushel:
Contract 1 – 5,000 bushels
Contract 2 – 7,500 bushels
Contract 3 – 10,000 bushels
When preparing his tax return, Farmer Jones finds out that instead of having taxable farm income of $100,000 (his desired amount), he has a loss of $25,000. To generate additional income, he can elect out of the installment method on contracts 2 and 3 and increase his income by $131,250. This will get him back to roughly his desired income. He could also pick 1 and 3 if he wanted to report slightly less income.
How we can help
Farmers who consistently use deferred payment contracts should make sure they right-size the contracts each year. To maintain the correct income tax treatment of these contracts, care must be taken to ensure that they are properly structured. GellerRagans can help with these requirements. Now is the time to contact us to maintain your 2012 tax planning flexibility.