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Agriculture Business Structuring and Wealth Planning

A Penny Saved: Business Planning and Wealth Preservation for Farmers

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Agriculture Business Structuring and Wealth Planning

9/10/2008
A Penny Earned - Structuring Business for Success
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Tax Savings Series Part 3 - "Minimizing Income Tax"

How to Minimize Income Tax or I Wear a Barrel Because Uncle Sam Took My Slacks
As I have mentioned in my previous posts, there are methods through which income tax obligations can be lowered. Robert A. Heinlein has warned: “Be wary of strong drink. It can make you shoot at tax collectors... and miss.” But I am hopeful that in this post I may be able to provide a few hints regarding the minimization of income taxes, which do not involve taxpayers cooling their heels in the gray bar hotel. Chief among these are utilizing the most advantageous accounting method; postponing income; and taking all applicable exclusions, deductions, exemptions, and credits.

Operating under the cash method of accounting can be an effective way of postponing income. There are two methods of accounting: the accrual method and the cash method. Under the accrual method income is included in the year that it is earned and expenses are deducted as incurred, whereas under the cash method income is included in the year in which it is received and expenses are deducted as paid. Most farmers are permitted to utilize the cash method of accounting, and can achieve significant tax savings through structuring transactions in an optimum manner.

At its most rudimentary, appropriate structuring under the cash method involves delaying the receipt of cash and accelerating the payment of expenses. This will result in decreasing Taxable Income in the present year at the expense of increasing Taxable Income in the next year, which is normally desirable for the reason that a dollar today is preferable over a dollar tomorrow. Although, a farmer who anticipates that next year will be significantly more profitable than this year may be well advised to accelerate his or her receipt of cash in the present year and delay his or her expenses until next year, as this would allow him or her to enjoy the benefit of lower marginal rates in the present year.

Postponing income means that the taxpayer will not pay tax on that income in the current tax year, but that he or she will be required to do so in the future. There are several ways in which income can be postponed (and, in fact, utilization of the cash method could be thought of as way of postponing income).

Section 1031 allows for the exchange of real property, such as farm ground, for “property of a like kind,” and instead of requiring the recognition of capital gain, the taxpayer is permitted to assign the basis of the old property to the new property. This means that the capital gain will have to be recognized at some point in the future when the new property is sold. Similarly, amounts contributed on behalf of a taxpayer to a 401(k) account (including SIMPLE 401(k) plans) are not treated as income until distributed. In 2008, a taxpayer may elect to defer up to $15,500 for this purpose.

The other method by which a taxpayer’s obligation may be reduced is by taking full advantage of all applicable exclusions, deductions, exemptions, and credits. One popular method for increasing deductions is depositing funds into an Individual Retirement Account (IRA). The maximum contribution amount eligible for deduction in 2008 is $5,000. Additionally, there are, of course, an abundance of other available exclusions, deductions, exemptions, and credits, but the trick here is to work with an accountant who can ferret all of these out.

Please join me next time for: The Self-Employment Tax or All These Taxes Are Taxing My Patience.