Farm Management Newsletter

Quarterly Publication of Ohio State University Extension

Winter 2001-2002

Farm Income Tax Update for 2001

By David Miller, District Specialist

The Economic Growth and Tax Relief Reconciliation Act of 2001 signed into law this year contains many changes to the current tax law. Agricultural producers will benefit primarily as individual taxpayers. The new law reduces tax rates, expands the child tax credit, addresses the "marriage penalty" for married couples filing jointly, increases education incentives and allows higher contributions and greater flexibility for IRAs and pensions. The most significant change for farms and small businesses is the reduction and eventual elimination of the federal estate tax. Here we highlight changes that will most affect 2001 income taxes paid by farm families.

New Tax Brackets

The new tax law creates a 10% income tax bracket for the first $12,000 of taxable income on a joint return ($6,000 for singles). The tax rebate checks issued during the summer and early fall represent the 5% reduction for the portion of your 2001 income that would have been taxed at 15% prior to the tax reduction.

The 15% tax bracket will remain unchanged, and the higher tax brackets are reduced through 2006.

Stay in Low Tax Brackets

One goal of tax planning and management is to make sure there is at least enough income to fully utilize the standard deduction and personal exemption allowances. If not, you will lose the benefit of these tax-free allowances.

The standard deduction for 2001 is $7,600 for married taxpayers filing jointly and $4,550 for single taxpayers. The personal exemption allowance is $2,900. For a family of four (husband and wife filing jointly with two dependent children), this means they can have taxable income of $19,200 and not have any income tax to pay. The same family with a taxable income of $31,200 will only pay $1,200 of income taxes (10% of $12,000) under the new tax rates.

By using your records and doing tax management and planning, you can avoid large fluctuations in your net farm income and make sure that you are taking maximum advantage of the lower tax brackets each year.

Have Up-to-Date Records

To do the necessary income tax planning to take advantage of the new, lower tax rates, an up-to-date set of personal and farm records is required. Most computer record-keeping programs can compare the current year's income and expenses to the previous year's figures.

While you will still need to estimate income and expenses for the remainder of 2001 and estimate your 2001 depreciation to estimate net farm income and to decide on your tax management strategy, this comparison feature is extremely useful in helping to monitor your net income.

Even though the options to manage your taxable farm income may be limited, you should always analyze your tax situation prior to the year's end. There are very few tax management options available after January 1.

Tax Management Strategies

Tax management strategies either increase net farm income or decrease it. If you need to increase net income, consider stepping up sales of farm products before year's end; postpone paying bills until after Jan. 1 and postpone capital purchases, if possible; do not claim section 179 expensing; and use slower depreciation rates for assets placed in service during 2001.

If your strategy is to reduce net farm income, delay sales if possible, pay all outstanding bills by Dec. 31, buy and pay for 2002 supplies before Dec. 31, consider capital purchases in 2001 that are planned for 2002, and use accelerated depreciation rates along with section 179 expensing, if applicable. But, always keep in mind that the profitability of the operation and not minimizing income taxes is first and foremost.

Prepaid Expenses

If you plan to pre-pay expenses for 2002, the method of payment for these supplies can be critical. If the 2002 supplies are paid for with cash or with borrowed funds from your lender, you have a qualified deduction for 2001. If the supplies are paid for by signing a promissory note with your supplier, you do not have a qualified deduction and the expense is claimed when the note is actually paid.

If your supplier has a financing subsidiary and you sign a promissory note for the supplies with the subsidiary, it is not clear if you can deduct the expense in the current year or when the note is actually paid. To be certain you have a qualified deduction, pay for your advanced purchases with cash or funds from a third-party lender.

Other requirements for qualified deductions are that the prepayment is for specific supplies, i.e., so many gallons, bushels, pounds, tons, etc., of specific inputs and not just a deposit towards next year's purchases. The prepaid expenses must have a business purpose, and they must not cause a material distortion of income.

Income Averaging for Farmers

Now you can use a Schedule F loss in a base year when making the calculations for Schedule J (Farm Income Averaging) for the current year. However, before using farm income averaging for 2001, you need to determine if there was a negative Schedule F income for one of the base years (1998, 1999, and 2000). If there was, determine if that year's negative taxable income would now allow you to use Schedule J for those prior years and file an amended tax return(s) if it will reduce your tax liability. Doing all this will allow you to take full advantage of the provisions of this election for 2001.

Alternative Minimum Tax (AMT)

The new tax law temporarily increases the Alternative Minimum Tax (AMT) exemption amount by $4,000 for married taxpayers filing jointly to $49,000 and by $2,000 for single taxpayers to $35,750 through 2004. Be aware that the use of farm-income averaging, large amounts of capital-gains income, and the new lower tax rates can all trigger potential AMT.

It is a good practice to complete Form 6251 as part of your tax preparation to determine if you are subject to the AMT. If there is no AMT liability, keep the completed Form 6251 as part of your tax records in case you are contacted by the IRS at a later date.

Be sure to check with your tax advisor to see what other changes in the new tax law can benefit you and your family.