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My accountant and lawyer are pretty smart.
Farmers, they tell me, are not always so smart. They say farmers are afraid to pay taxes and make some of the worst tax decisions around. Farmers try to get their income to zero every year, which can end up destroying their cash flow and thus, their whole operation.
My two advisors have taught me some valuable lessons about taxes that other farmers need to hear, too. The simple lesson running through this article is this: pay, but plan, your taxes.
Specifically, there are six things you need to consider for farm tax management.
1) Accelerated Depreciation
Section 179 of the tax code is available to everyone. It “allow[s] businesses to deduct the full amount of the purchase price of equipment (up to certain limits).”
Let’s say you’ve made a lot of money this year—$500,000. That puts you above $400,000, the highest tax bracket, so you’re going to pay 40% in taxes plus any state tax. Section 179 allows you an accelerated depreciation of new machinery up to $500,000, to get your tax liability down.
In other words, you can buy $150,000 worth of equipment that you need, or a bunch of stuff you don’t, to get your tax liability down to zero. Farmers are often guilty of this. They go out and buy many things that they don't necessairly need to improve their opeartion.
The problem is, when you do that you burn through your cash. If you made $500,000 and want to get your tax liability down to $250,000, you’ll have to spend $250,000 in cash. But just because you have a quarter-million dollars in tax liability, it doesn’t mean you have a quarter-million in cash.
Accelerated depreciation, I think, is a weapon of business destruction, because it rewards businesses for burning cash. Tread lightly.
2) Cash Flow
Don't spend a dollar to save 40 cents.
If you don’t need to buy anything, don’t. The cash you relinquish by making unnecessary purchases outweighs any benefits..
You’ve got to have enough cash to cover your land and equipment payments. Businesses don’t fail because they don’t make enough money: they fail because they don’t have enough cash. The last thing you want to do is ruin your cash position to save a little tax liability.
We talked about "Cash is King" in an earlier post.
3) Do You Need It
Sam Walton and other “lean and mean operators” have set an awesome business standard with their office setups. Corporate offices often have lavish expenditures, on desks and tables and window curtains. In contrast, Sam Walton literally had card tables set up in his back offices, not wanting to spend more than he needed.
You might want to run your farm the same way. Your combine’s not obsolete after one year, so stick with it. Buy what you need and leave what you don’t.
4) Tax Planning
If your farm size is consistent over a period of 3-5 years, you can probably figure out what to expect for income. Once you do, you can manage your budget to plan for tax payment. You can put aside 40% (or whatever appropriate percentage) of your average annual income in cash, so tax time doesn’t sneak up on you.
5) Estate Planning
When I’m dead, I won’t care what happens to my farm.
This is a common sentiment among farmers. Others expect their affairs to sort themselves out in the end. When left alone, they rarely do.
When you pass away, depending on the laws at that time, you could lose a lot of your farm because of inheritance tax. Inheritance tax is the top rate: 40%, plus any state tax. Think about preparing your heirs for that future tax as you go, by purchasing life insurance or giving them a lot of your assets before you pass away.
Many farm magazines have specific sections on moving to the next generation. Check them out!
6) Get a Professional
You need help from two people when tax time rolls around.
One is a professional accountant who understands your industry. That last part is important: you don’t want one from California who works with movies. You want the right fit.
Ernst & Young accountants are great examples, but ask the big farmers in your area who they use.
The second professional you need is an estate planning legal advisor. Again, you need someone very familiar with your industry, who knows how to write deeds for land purchases and how to wrap things up into estates.
Yes, it’s an added cost, but it may save you a million dollars over the next five years. That kind of advice is priceless.
Taxes are daunting, but it’s possible to handle them well.
If you’ve read a few Cash Cow blog posts, you’ve probably notice a trend: I highly suggest finding an advisor for every part of your farm operation. That’s the most important piece of advice I can give for farm tax management.
Get good people on your team, and you’ll go far.
You may take a hit with taxes, but the government also offers a few great benefits for farmers. Check them out.
Cash Cow Farmer was created to keep you from leaving a single dollar of profit on the table. Give it a look to learn more about how Cash Cow optimizes your operation!
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