Farm Income Tax Management Chapter 16---Key Questions What types of income are taxable? What types of income are taxable? What are the differences between income tax and self-employment tax? What are the differences between income tax and self-employment tax? What strategies can be used to maximize after-tax income? What strategies can be used to maximize after-tax income?

Types of Taxable Farm Income Ordinary farm income (Schedule F) Ordinary farm income (Schedule F)  Federal income tax  State income tax  Self-employment tax Capital gains income Capital gains income  Capital gains tax (lower rates)

IRS Schedule F Gross Farm Income - Farm Expenses (including depreciation) = Net Farm Profit Can use cash or accrual. Most use cash. Can use cash or accrual. Most use cash.

Self-employment Tax Up to $94,200 taxed at 12.4% for Social Security Up to $94,200 taxed at 12.4% for Social Security All of it is taxed at another 2.9% for Medicare All of it is taxed at another 2.9% for Medicare

Income Tax Deductions Standard deduction Standard deduction  $5,150 for single person  $10,300 for married couple Can itemize deductions instead Can itemize deductions instead Personal exemption of $3,300 / dependent Personal exemption of $3,300 / dependent Family of one has $8,450 tax free income Family of one has $8,450 tax free income Family of 4 has $23,500 tax free income Family of 4 has $23,500 tax free income Remainder is Taxable Income Remainder is Taxable Income

Income Tax Rates Federal (married, joint) Taxable IncomeMarginal Rate $0 to 15,10010% $0 to 15,10010% $15,100 - $61,30015% $15,100 - $61,30015% $61,300 – 123,70025% $61,300 – 123,70025% $123,700 - $188,45028% $123,700 - $188,45028% $188,450 - $336,55033% $188,450 - $336,55033% Over $336,55035% Over $336,55035%

Iowa Income Tax Rates Increases gradually from ½ % up to 9% at $56,000

Example Taxable income = $70,000 Taxable income = $70,000 1 st $15,100 10% = $1,510 1 st $15,100 10% = $1,510 2 nd $61,300 – 15,100 = 15% = $6,930 2 nd $61,300 – 15,100 = 15% = $6,930 3 rd $70,000 -$61,300 = 25% = $2,175 3 rd $70,000 -$61,300 = 25% = $2,175 Total tax owed = $10,615 Total tax owed = $10,615

Tax Credits Credits are subtracted from the amount of tax owed. Credits are subtracted from the amount of tax owed. $1,000 credit for each child under 18 $1,000 credit for each child under 18 $2,000 credit in 10% bracket could offset $20,000 of taxable income $2,000 credit in 10% bracket could offset $20,000 of taxable income Family of 4 could have $43,500 of taxable income without any federal income tax. Family of 4 could have $43,500 of taxable income without any federal income tax.

Marginal Tax Rates (last $)

Total Tax Rate

Capital Gains Income When capital assets are sold for more than original tax basis When capital assets are sold for more than original tax basis Taxed at 5% or 15% Taxed at 5% or 15% Not subject to self-employment taxes Not subject to self-employment taxes Breeding livestock Breeding livestock  raised animals have zero basis, so all sales are capital gains

Individual Income Tax Return Farm income + wages, etc. Farm income + wages, etc. - deductions and exemptions = taxable income x tax rates = income tax + self employment taxes + capital gains taxes - tax credits = total taxes

Tax Management Strategies 1. Level out income from year to year, avoid high marginal tax brackets Example: Taxable IncomeFed Income Tax Example: Taxable IncomeFed Income Tax  year 1:$ 90,000$16,000  year 2:$ 10,000$ 1,000  $17,000 Level income: Level income:  year 1$ 50,000$ 6,800  year 2$ 50,000$ 6,800  $13,600 Saving $ 3,400 Saving $ 3,400

2. Defer income into future tax years, e arn interest on tax $ $30,000 x 25% tax rate = $7,500 $7,500 x 8% interest rate = $600  Use cash accounting to:  Delay income  Move up expenses Use fast depreciation rates Use fast depreciation rates

Tax Management Strategies 3. Report enough income to use up personal deductions and credits 4. Qualify income as capital gains when possible 5.Use net operating losses (NOL) to offset past taxes 6. Use income averaging (back 3 yrs)

Goal of Tax Management Maximize long-run income after taxes, not minimize taxes.