A Taxing Attitude Eric J. Deters, FBM Instructor, Riverland Community College

There are only two sure things in this world. Death and Taxes But timing is critical

Question: Is it better to pay a prepay for inputs or pay the tax and pay down debt?

Situation: Producer just purchased a different combine and secured a $50,000 loan in order to make the purchase. At the end of the year he finds he has $30,000 dollars to spend. Does he use the $30,000 for prepay or pay the taxes and reduce the loan?

Producer background: Married with 2 dependents. Farm 1000 acres on a 50/50 corn bean rotation. One spouse works off farm and generates 32,000 in income. 30% of the crop is sold in fall the rest is stored and sold in the spring.

Let’s answer the question: Do I buy inputs or pay tax and debt? $50,000 Equip Loan, 7% int. 5 year Am P&I = $12,194.53 due 9/1 Added Tax on $30,000 = $10,386 $19,614 to pay down debt Loan Schedule Normal Pay Debt Balance Int. Paid Balance Int. Paid Year 1 50,000 30,386 Year 2 41,305 3500 20318 2172 Year 3 32,002 2891 9546 1422 Year 4 22,047 2240 0 668 Year 5 11,397 1543 Year 6 0 798 Total Interest Paid $10972.67 $4262.52

Let’s answer the question: Do I buy inputs or pay tax and debt? $50,000 7 yr SL Depreciation = 7142.85/ yr. P&I = $12,194.53 Normal Tax base $63,000 + Loan payment – (Interest & Deprecation) Future Tax Normal Pay Debt Income Tax Income Tax Year 1 75195 15679 75195 16138 Year 2 75195 15889 75195 16398 Year 3 75195 16115 64981 15973 Year 4 75195 16356 63000 12729 Year 5 75195 16614 63000 12729 Year 6 63000 12729 63000 12729 Total Tax Paid $93382 $86759

Let’s answer the question: Do I buy inputs or pay tax and debt? Summary Normal Pay Debt Difference Interest $10,973 $4,263 $6,710 Future Tax $93,382 $86,759 $6,623 Total Savings $13,333

What about the $10,386 in taxes paid the first year? WHOA, What about the $10,386 in taxes paid the first year?

Remember the producer has $30,000 in prepay that has not been yet Remember the producer has $30,000 in prepay that has not been yet. Thus he still has a deferred tax liability of $10,386. So it Washes

The Dangers of PREPAYS: Lets say the producer makes $93,000 for the next 6 years. One strategy is to keep add to the prepay, another to pay the tax and reduce debt. He is not opposed to paying tax on $63,000 a year. All Prepay All Debt Payment Total Prepay $180,000 Total Debt Reduced $117,684 + Tax Due $66,676 $62,316 Net Worth $113,324 $117,684 + $5115 paid into SS

Sure, but real life is not as consistent as your examples Sure, but real life is not as consistent as your examples. Incomes and expenses fluctuate giving us opportunities for tax savings.

Let’s look at 3 strategies using real numbers from FINBIN. Fair enough. Let’s look at 3 strategies using real numbers from FINBIN.

No tax planning, doesn’t care, just pay the tax. Strategy 1 No tax planning, doesn’t care, just pay the tax.

PAY NO TAX, prepay any amount to avoid tax Strategy 2 PAY NO TAX, prepay any amount to avoid tax

Strategy 3 Planner, try to stay in the 15% bracket, pays down debt when ever possible.

The income numbers used are the average net returns of corn and soybeans for the 2000 thru 2006.

Let’s use the same producer. Here is some added info: Total Assets – 1,187,500 Intermediate Debt – 75,000 7% 7 years Long Term Debt – 400,000 Needs $40,901 to pay a portion of family living and principle payments.

YEAR 1 Income: $108,270 1 2 3 Taxable Income $ 108,270 $108,207 $108,207 Carry over Prepay 0 0 0 Prepay 0 $108,207 $ 5,000 Taxable Income $108,270 0 $103,207 Tax $ 38,741 0 $ 37,026 Family Living /Prin Pay $ 40,901 $40,901 $ 40,901 Debt Reduction 0 0 $ 35,000 Cash Balance $ 28,627 0 $ 1,177 Borrowed Balance 0 $40,901 0 Int Loan Balance $ 66,333 $ 66,333 $ 31,333 Lt Loan Balance $395,765 $395,765 $ 395,765

YEAR 2 Income: $76,250 1 2 3 Taxable Income $ 76,250 $ 76,250 $ 76,250 Carry over Prepay 0 $108,207 $ 5,000 Prepay 0 $183,805 $ 15,000 Taxable Income $ 76,250 0 $ 66,250 Tax $ 27,758 0 $ 23,879 Family Living /Prin Pay $ 40,901 $40,901 $ 40,901 Debt Reduction 0 0 $ 0 Cash Balance $ 36,218 0 $ 2,647 Borrowed Balance 0 $ 81,802 0 Int Loan Balance $ 57,060 $ 57,060 $ 19,611 Lt Loan Balance $391,234 $391,234 $ 391,234

YEAR 3 Income: $32,810 1 2 3 Taxable Income $ 32,810 $ 32,810 $ 32,810 Carry over Prepay 0 $183,805 $ 15,000 Prepay 0 $ 215,183 $ 0 Taxable Income $ 32,810 0 $ 47,810 Tax $ 11,754 0 $ 16,938 Family Living /Prin Pay $ 40,901 $40,901 $ 40,901 Debt Reduction 0 0 $ 0 Cash Balance $ 16382 0 $ 0 Borrowed Balance 0 $122,703 $ 7,382 Int Loan Balance $ 47,138 $ 47,138 $ 7,067 Lt Loan Balance $386,386 $386,386 $ 386,386

YEAR 4 Income: $41200 1 2 3 Taxable Income $ 41,200 $ 41,200 $ 41,200 Carry over Prepay 0 $ 215,183 $ 0 Prepay 0 $ 254,236 $ 0 Taxable Income $ 41,200 0 $ 41,200 Tax $ 14,649 0 $ 14,649 Family Living /Prin Pay $ 40,901 $40,901 $ 34,546 Debt Reduction 0 0 $ 0 Cash Balance $ 2,032 0 $ 0 Borrowed Balance 0 $163,604 $ 15,377 Int Loan Balance $ 36,521 $ 36,521 $ 0 Lt Loan Balance $381,198 $381,198 $ 381,198

YEAR 5 Income: $53,700 1 2 3 Taxable Income $ 53,700 $ 53,700 $ 53,700 Carry over Prepay 0 $ 254,236 $ 0 Prepay 0 $ 305,703 $ 0 Taxable Income $ 53,700 0 $ 53,700 Tax $ 18,977 0 $ 18,977 Family Living /Prin Pay $ 40,901 $40,901 $ 26,985 Debt Reduction 0 0 $ 0 Cash Balance $ 0 0 $ 0 Borrowed Balance $ 4,146 $204,505 $ 7,639 Int Loan Balance $ 25,161 $ 25,161 $ 0 Lt Loan Balance $ 375,648 $ 375,648 $ 375,648

YEAR 6 Income: $-13,820 1 2 3 Taxable Income $ -13,820 $ -13,820 $ -13,820 Carry over Prepay 0 $ 305,703 $ 0 Prepay 0 $ 287,674 $ 0 Taxable Income $ -13,820 0 $ -13,820 Tax $ -4,845 0 $ -4,845 Family Living /Prin Pay $ 40,901 $40,901 $ 26,985 Debt Reduction 0 0 $ 0 Cash Balance $ 0 0 $ 0 Borrowed Balance $ 54022 $245,406 $ 43,599 Int Loan Balance $ 13,006 $ 13,006 $ 0 Lt Loan Balance $ 369,709 $ 369,709 $ 369,709

YEAR 7 Income: $ 42,780 1 2 3 Taxable Income $ 42,780 $ 42,780 $ 42,780 Carry over Prepay 0 $ 287,674 $ 0 Prepay 0 $ 326,160 $ 0 Taxable Income $ 42,780 0 $ 42,780 Tax $ 15,196 0 $ 15,196 Family Living /Prin Pay $ 40,901 $40,901 $ 26,985 Debt Reduction 0 0 $ 0 Cash Balance $ 0 0 $ 0 Borrowed Balance $ 67,339 $286,307 $ 43,000 Int Loan Balance $ 0 $ 0 $ 0 Lt Loan Balance $ 363,354 $ 363,354 $ 363,354

Summary 1 2 3 Taxes Paid $ 122,221 $ 0 $ 121,820 Deferred Tax Prepay 0 $ 127,475 $ 0 Deferred Tax Liability $ 24,357 $ 110,346 $ 15,273 Total Tax Liability $ 146,578 $ 237,821 $ 137,093 Assets $ 1,187,500 $1,187,500 $ 1,187,500 Prepay 0 $ 326,160 $ 0 Total Assets $ 1,187,500 $1,187,500 $ 1,187,500 Current Liability $ 67,339 $286,307 $ 43,000 Lt Loan Balance $ 363,354 $ 363,354 $ 363,354 Total Liabilities $ 430,693 $649,661 $ 406,354 Net Worth $ 756,807 $863,999 $ 781,146 Net Worth w/Def Lib $ 732,450 $ 626,178 $ 765,873

Tax Planning for the Near Future Accept the fact that you will pay taxes sooner or later. Waiting may be disastrous. Save 3-5% of your sales in a money market to help easy the pain of coming up with money to pay taxes. PAY DOWN DEBT!!!! Even a small percentage of debt reduction can make a big difference. Pay accounts and loans timed with expenses or depreciation. Thus the priority order, Accounts Payables, Current Loans (operating), Intermediate (Breeding Stock/Machinery), Long Term Loans (mortgages). Keep ACCURATE records and start planning early.

Taxes take a percentage, they don’t take it all. Parting Thoughts: If your not paying taxes, you have more to worry about than paying taxes. Taxes take a percentage, they don’t take it all. Don’t let taxes prevent you from making a profit.