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Colorado State Filing Taxes

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					Larimer & Boulder Counties, Colorado
        2008 December 17th
                                                   Jeff Tranel

• Agricultural and Business Management Economist
  – Ranch raised
  – Colorado State University
      Extension
      Department of Agricultural & Resource Economics

  – jtranel@colostate.edu
  – www.coopext.colostate.edu/tranel


• I am not a Certified Public Accountant



                                                                 2
                                          Income Taxes

• Congress alters tax code periodically
• Tax Court rules on tax issues

• Can often be
  interpreted in multiple ways

• Income tax codes and
  regulations are complex.

       Please consult with
    your tax practitioner about
          application of
    tax codes and regulations.
                                                         3
                              What Are Your Goals?

1. To make money
      Short term?
      Long term?
2. Taxes
      No taxes?
      Minimize taxes?
      Pay more taxes every year?
3. Equity (net worth)               “A farmer will never go
                                      broke paying taxes”
      Maintain?
      Increase?                         - Anonymous Farmer


                                                              4
                     Your Goals




   ExxonMobil        ExxonMobil
After tax income =     Taxes =
    $22.6 billion    $61.7 million




                                     5
Definition of a Farm
                                 For Profit Farming

• It is a business if there is
  net income or profit in
  three of last five years

• Activities consisting of
  breeding, showing or
  raising horses, it is a
  business if there is a
  profit in
  two of last seven years


                                                      7
                                                     Intent to Profit

• Farming for profit
   –   Operate in business like manner
   –   Time and effort
   –   Depend on farming for livelihood
   –   Losses due to circumstances beyond your control
   –   Change operation in attempt to increase profitability
   –   Have necessary knowledge
   –   Past success
   –   Profits earned in some years
   –   Expect profits in future years




                                                                        8
                                    Hobby Farming

• Definition
   – Profit is not primary motive
   – Farm income not primary
     source of income


• Tax Implications
   – Limit on deductions
   – Cannot use loss to offset
     income from other activities
   – Report income on Form 1040
     and deduct expenses on
     Schedule A (Form 1040)


                                                    9
                                          Qualified Farmer?

• 2/3 of Gross Income
   – must come from farming/ranching
     in current or prior year

• Gross Income = All Income

• Farm Income
  = Income from Farming/Ranching
      (Schedule F)
  + Gross Farm Rental Income
      (Form 4835)
  + Gross Farm Income
      (Schedule E, Parts II & III)
  + Gains from Sale of Breeding Animals
      (Form 4797)
                                                              10
Material Participation




                         11
                                 Material Participation

1. Regularly and frequently makes, or takes an important
   part in making, management decisions.
2. Works 100 hours or more spread over a period of 5
   weeks or more.
3. Does things that, considered in their
   totality, show material and significant
   involvement.
4. Does any three of the following:
   a.   Pays half
   b.   Furnishes
   c.   Advises or consults
   d.   Inspects
                                                           12
                                          Material Participation

• Income and deductions from
  farm rentals, including
  government payments
  received by the landowner,
  are subject to self
  employment (SE) tax, if:
   – Sell, exchange, give away, or
     use the crop shares
   – Materially participate at the time
     the crops are produced




                                                                   13
Importance of Records
                                                 Records

• Meet the needs of:
   –   You
   –   Lender
   –   Tax preparer
   –   Other


• Are required by the IRS to be
  kept for 3 years after date of filing
   – 7 years in cases of suspected fraud
   – Applicable years regarding capital assets



                                                           17
Farm Income
                                                     Farm Income

• Sales of livestock and other items purchased for resale
   – Sales of farm products purchased for resale
   – Profit or loss is the difference between the basis in the item,
     usually the cost, and any payments received
   – Basis may have been carried forward from a previous year


• Sales of livestock, produce, grains, and other products
  raised
   – Sales of all raised products




                                                                       27
                                                   Farm Income

Agricultural Program Payments
– All agricultural program payments, including CRP payments
    Even if a government check was returned for cancellation or
       the government collects all or part of the payments by reducing
       the amount of another payment or CCC loan
– The government should send the taxpayer a Form 1099-G
  indicating the total amounts received


Crop Insurance Proceeds
– Proceeds from insurance on growing crops
    Included in gross income in the year actually or constructively
     received.


                                                                         28
                                                     Farm Income

Crop Insurance Proceeds
– Proceeds from insurance on growing crops
   Included in year actually or constructively received

– Can be postponed until following year if:
   Use cash method of accounting
   Received insurance proceeds in same tax year as crops
    damaged
   Normal business practice to sell crop in following year




                                                                   29
                                                  Farm Income

Other Income
   – Items that generate income during the year.
        Crop share rents
        Breeding fees
        Sales of soil
        Items not included in other sections of farm income.




                                                                30
                                                 CRP Payments

• Before
   – If actively farming, active income (Sch. F)
   – If not actively farming, passive income (Sch. E)


• Now
   – By complying with terms of CRP contract, you are actively
     farming
        CRP payments are considered “government payments” not
         rental payments


• After 2007
   – If receiving Social Security benefits (retirement or disability)
        CRP payments are excluded from self-employment income

                                                                        31
                          Hedging as Risk Management

• Hedging transactions entered into
  in normal course of business

• For risk management purposes

• As forward contracts, futures
  contracts, options

• Commodity is produced on the
  farm or directly affects the
  business

• Generally an ordinary gain or loss

• Reported on Schedule F
                                                       32
                                  Hedging as Speculation

• Hedging transactions
  entered into which are not
  part of the ordinary business
  of farm

• Has specific record keeping
  requirements

• Reported on Form 1040




                                                           33
Farm Expenses
                                                Farm Expenses

•   Ordinary and necessary costs of operating a farm or agricultural
    enterprise.

•   Capital improvements increase basis of applicable assets.

•   Depreciation reduces basis.

•   Expenditures for purchases of items for resale are not deductible
    in year occurred (under cash method).




                                                                        36
                                  Car & Light Truck Expenses

• Must be able to prove deduction for travel with adequate
  records or other evidence.
   – Example: account book supported by things such as expense
     receipts
• Not deductible for commuting miles
• Depreciation limited (if placed in service in 2007)
   –   $3,060 in 1st year
   –   $4,900 in 2nd year            Limits are higher for light trucks,
   –   $2,850 in 3rd year              vans , and electric vehicles.

   –   $1,775 in 4th and later years
• $25,000 max depreciation-for SUVs
                                                            Assumes
   See Publication 946.                                 100% business use.
                                                                             37
                               Car and Light Truck Expenses

• Up to 75%
  – Directly in connection with farming
  – In first year the vehicle is placed in service
  – Cannot change to another method at later
    time
• 100%
  – Must have records of proof
  – Must be used for business the percentage
    that is claimed




                                                              38
                             Car and Light Truck Mileage

• Standard mileage rate
   – $0.505 in 2008 (Jan 1 – Jun 30)
   – $0.585 in 2008 (Jul 1 – Dec 31)

   – Business miles only
   – Not deductible for commuting
     miles
   – Cannot be used if operating 5+
     cars and light trucks at the
     same time

   – Business rate in 2009 = $0.55


                                                           39
                                Prepaid Livestock Feed

• Deduct the cost of livestock feed to
  be consumed in a later year if
  (meet all tests)

• Deductions for prepaid livestock
  feed may be limited to 50% of
  other deductible farm expenses




                                                         40
                                     Prepaid Livestock Feed

1. Payment is for the purchase of feed rather than a deposit
   • Specific quantity
   • Fixed price
   • Not entitled to refund or repurchase

   • Would be considered a deposit if:
      Absence of specific quantity terms
      Right of refund of any unapplied
       payment credit
      Right to substitute other goods or products
      If there is a provision in a binding contract permitting
       substitution of ingredients to vary particular feed mix to meet
       livestock’s current diet requirements will not suggest a deposit
                                                                          41
                                   Prepaid Livestock Feed

2. Prepayment has a business purpose and is not merely
   for tax avoidance.
   • Reasonable expectation of receiving
     some business benefit for prepayment
   • Examples
       Fixing maximum prices
       Securing assured feed supply
       Securing preferential treatment
        in anticipation of a feed shortage




                                                            42
                                   Prepaid Livestock Feed

3. Does not materially distort income.
   – Customary business practice
   – Expense in relation to past purchases
   – Expense in relation to income
     for the year
   – Time of year




                                                            43
                                         Prepaid Livestock Feed

Summary for deduction of prepaid livestock feed:

•   Payment is for feed, not a deposit

•   Payment has business purpose,
    not for tax avoidance

•   Prepayment does not
    materially distort income




                                                                  44
                                 Wages for Labor

• Deduct reasonable wages

• Use fair market value of any
  assets given to hired labor

• Deduct as farm expenses
  the costs of boarding farm
  employees

• Issue Form W-2 for all
  employees


                                                   45
                        Contract vs. Employee Labor

• Entered as “custom hire”

• Cost must be capitalized

• “20 Factors”

• Individual contractors
  receiving more than $600
  must receive a Form 1099-
  MISC




                                                      46
                      Hired Labor- Family Members

• Deduct reasonable wages and
  other compensation paid your
  child

• Deduct reasonable wages and
  other compensation paid your
  spouse




                                                    47
                                     Prepaid Farm Supplies

• Amounts paid during the tax
  year for feed, seed, fertilizer,
  and similar farm supplies

• Must use cash method of
  accounting

• Limited to 50% of other
  deductible farm expenses




                                                             48
                                    Prepaid Farm Supplies

Exceptions to the 50% Limit:

• Does not apply to farm-related
  taxpayers if:
   – Business operations changed due
     to unusual circumstances
   – Total prepaid farm supplies in
     preceding 3 years is less than 50%
     of total other deductible farm
     expenses in those three years




                                                            49
                                   Business Use of Home

• Can deduct expenses for
  business use of home if part of
  the home is used exclusively and
  regularly

• Deduction limit applies

• Any depreciation taken reduces
  the home’s basis




                                                          50
                  Business Use of Home - Telephones

• Cannot deduct cost of basic local telephone service for
  the first telephone line into the home

• Can deduct:
   – Business long-distance changes on the first line
   – Cost of second telephone line into the home if used exclusively
     for farm business




                                                                       51
                                     Depreciation

• Annual deduction recognizing
  that assets wear out or become
  obsolete

• Types of tangible property

• To be depreciable, property must
  meet conditions

• Records of depreciation on
  capital assets must be kept by
  the taxpayer

                                                    52
                                                     Depreciation

• To be depreciable, property must (meet all tests):
   –   Be owned
   –   Used in the business or income producing activity
   –   Have a determinable useful life
   –   Be expected to last more than one year


• Most types of tangible property.
   –   Buildings
   –   Machinery & equipment
   –   Vehicles
   –   Livestock
   –   Fences
   –   NOT land
                                                                    53
                                               Depreciation

                                       Recovery Period in Years

                                         GDS            ADS

Single purpose ag structure               10             15

Single purpose horticulture building      10             15

Farm buildings                            20             25

Farm machinery and equipment               7             10

Ag fences                                  7             10

Truck (13,000 lbs or more)                 5             6

Water wells                               15             20
                                                                  54
                                                   Depreciation

                                           Recovery Period in Years

                                             GDS          ADS

Cattle (dairy and breeding)                    5             7

Goats and Sheep (breeding)                     5             5

Horses (age when placed in service)
 Breeding & Working (12 years or less)         7           10
 Breeding & Working (more than 12 years)       3           10

Hogs (breeding)                                3             3


                                                                      55
                     Depreciation – Breeding Livestock

• Raised breeding livestock:
   – Not typically depreciated
   – Incurred expenses deducted as ordinary farm expenses
   – Have no basis when sold
        Sale price less selling costs equal capital gains




                                                             56
                                            Depreciation Limits

• Limits
   –   Passenger automobiles of < 6,000 lbs (GVW)
   –   Entertainment and recreational property
   –   Computers
   –   Cellular telephones
   –   Generally, most assets that lend themselves to personal use




                                                                     57
                            Depreciation – Section 179

• Allows deducting all or part of
  qualifying property in the year
  “placed in service”

• Qualifying property

• Property must be used more than
  50% for qualified business use




                                                         58
                                         Depreciation - Section 179

• Allows deducting all or part of qualifying property in the year “placed
  in service”.
• Qualifying property:
    –   Purchased for business use
    –   Personal property, ag fences
    –   Single purpose ag structures
    –   Does not include real property
• Property must be used more than 50% for qualified business use.
• Limits in 2008
    – Apply to individuals
    – $250,000 for married couples filing jointly (MFJ)
    – Reduced as total cost of all qualifying section 179 property placed in
      service within the tax year exceeds $800,000


                                                                               59
                                   Depreciation – Example 1



$125,000   Adjusted purchase price for machine

     - 0   Section 179 Allowance

 125,000   Depreciable basis

     / 7   Years of recovery

= 17,557   Depreciation using SL method

 X 50%     Calculation for half-year convention

= $8,929   Depreciation for 1st year (year placed in service)
                                                                60
                                    Depreciation – Example 2



$125,000    Adjusted purchase price for machine

- 100,000   Section 179 Allowance

  25,000    Depreciable basis

      / 7   Years of recovery

  = 3,571   Depreciation using SL method

  X 50%     Calculation for half-year convention

 = $1,786   Depreciation for 1st year (year placed in service)
                                                                 61
               Multi-Year Effects of Depreciation Decisions


                     2003        2004   2005     2006      2007    2008     Total

Loan Payments

  Interest                        870    662      447       227             2,206

  Principal                     7,182   7,390    7,604     7,825           30,000

Example 1: Using MACRS Depreciation


Depreciation         4,500      7,650    5,355     4,998   4,998   2,499   30,000


Tax savings          1,679      3,178    2,244     2,031   1,949    932    12,013


Revenue needed                  7,773    9,262     9,602   9,733           36,370


                                                                                    62
Strategies for Managing Tax Liability
                                Tax Management Goals

• It may not be best to minimize
  taxes
• Should maximize after tax
  income across multiple years
• Matching depreciation
  deductions to loan payments
• May not “show up” on financial statements
• Tax management decisions in one year can affect cash
  flow and financial viability of a firm in future years

                                                           64
                                Tax Management Goals

• Match depreciation deductions
  to loan payments

• Manage taxes and financial
  risk over multiple years

• May want to take bigger
  deductions up front to keep
  out of a higher tax bracket

• Deferred taxes may not catch
  up to the farmer until retirement

                                                       65
                               Defer Tax Payments


• Tax minimizing strategies
  only defer (delay) income
  tax payments

• Many farmers report crop
  revenue in one year and
  expenses on another
  year’s tax return

• Large tax consequences
  may result at a time when
  financial hardship already
  exists
                                                    66
                   Reducing Profits – Gross Income

• Postpone receipt of revenues

• Reduce revenues from livestock and crop sales

• Reduce non-livestock/crop revenues




                                                     67
                        Reducing Profits – Expenses

• Prepay supplies
• Prepay feed
• Increase expenses
• Increase depreciation
• Pay higher than necessary
  prices
• Use extraordinary amounts of
  items
• Pay consultants



                                                      68
                           Increase Taxable Income

• Reasons why someone might want to increase taxable
  income:




                                                       69
                           Increase Taxable Income

• Reasons why someone might want to increase taxable
  income:




                                                       70
                           Increase Taxable Income

• Reasons why someone might want to increase taxable
  income:




                                                       71
                           Increase Taxable Income

• Reasons why someone might want to increase taxable
  income:




                                                       72
Taxes
                                  Self Employment Taxes

Rate = 15.3%
   – Social Security = 12.4% (max earnings = $102,000)
   – Medicare = 2.9% (max earnings = unlimited)


Net Farm Income + Other SE Income
X 92.35%
= Net Earnings From SE
X 15.3%
= Self-employment Taxes
                                 If net earnings from self-employment
                                            is less than $400,
                                        there is no SE Tax liability.

                                                                        74
                                     SE Taxes – 4-H/FFA

• Sales of 4-H and FFA projects
  are generally not subject to SE
  taxes
   – Project must be primarily for
     educational purposes
   – Project completed by the
     individual under rules and
     economic restrictions of the
     sponsoring 4-H or FFA
     organization




                                                          75
                   Standard Deductions & Exemptions

2008
• Standard Deductions (under 65)
   – $ 5,450 Filing Single
   – $10,900 Married Filing Jointly
   – $ 8,000 Head of Household


• Personal Exemptions
   – $ 3,500 per dependent
   – Phased out as adjusted gross income certain level




                                                         76
                      Tax Rate Schedule (MFJ) - 2008


 Income Range                         Income Tax

More Than       Less than    Amount    Plus Percent times Amount Over

      ---       16,050          ---            10%                      0

 16,050         65,100       1,605             15%              16,050

 65,100     131,450          8,963             25%              65,100

131,450     200,300         25,550             28%            131,450

200,300     357,700         44,828             33%            200,300

357,700               ---   96,770             35%            357,700

                                                                            77
                                       Retirement Accounts

• Traditional IRAs                   • Roth IRAs
  – Adjustments to gross               – Taxed in year of investment
    income                             – No required distribution
  – Taxed when withdrawn               – Contribution limits, generally
  – Required distribution (70 ½)           $5,000 in 2008
  – Contribution limits, generally         $6,000 in 2008 (if 50+)
      $5,000 in 2008
      $6,000 (if 50+)
                                     • SIMPLE, SEP-IRA, Keogh,
                                       Other

                                     • Publication 590

                                                                          78
                                                Estimated Taxes

• Farmers not required to make estimated payments.
   – Qualified farmer
   – File tax return and pay all taxes by March 1st


• Qualified farmer can make a single estimated payment
  by January 15th
   – Then has until April 15th to file tax return and pay balance of
     taxes owed


• Making estimated payments
   – Must, if above to not apply
   – May


                                                                       79
                                              More Information

• See your tax preparer

• Visit the IRS
   – Telephone
   – Website (www.irs.gov)
   – Publications and Forms
       Publication 225 (farmers tax guide)




                                                                 80

				
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