Mr. David Miller, Farm Management Specialist, Ohio State University Extension
As the end of 2004 approaches, dairy farmers need to be thinking about the income and social security tax liability that will be due March 1 (or April 15th) of 2005. While milk prices have improved over the past year and beef prices for cull cows have remained high, they need to focus on their net farm income since the costs of inputs have also risen. How does the projected 2004 net farm income for your dairy compare to 2003? 2002? Is it up? Down? About the same? Once that question has been answered, then decisions about tax management strategies for 2004 can be made. Since year-to-year fluctuations in taxable income cause a taxpayer to pay more income taxes over time, the objective of tax management is to level out those fluctuations so less tax is paid.
Keep in mind also that normally 70 to 75% of the total tax bill for a dairy farmer is for self-employment (SE; social security) taxes. Depending on the situation, paying SE taxes protects the dairy farmer's family by keeping them qualified for death and disability benefits and ultimately for retirement benefits. While minimizing the income tax bill may be desirable, not paying SE taxes is hardly an option.
If the net farm income is up for 2004, then consider strategies to reduce net income. These include paying all past due bills, purchasing inputs for 2005, postponing the sale of cows and calves if their sale is close to year's end, paying the interest up-to-date on all outstanding farm loans, and replacing additional, but needed, capital items and place them in service in 2004. Investing in a traditional individual retirement account (IRA), if eligible, will reduce taxable income for the family and is a good way to set aside additional funds for retirement. This is something all farm families should take advantage of whether it has been a good year or not.
If net farm income is down for 2004, then the strategies are just the opposite. Postpone paying bills until after January 1, sell any cows and calves before December 31 to claim the income in 2004, collect money that might be owed to you, and postpone purchasing capital items that would be placed in service in 2004.
For new capital items placed in service during 2004, choice of depreciation methods can also affect net farm income. If you need additional deductions, consider various combinations of accelerated depreciation, 179 expensing, and the additional 30% or 50% first year depreciation. If you don't need additional depreciation deductions, use slower straight line methods and use the 179 expensing and additional first year depreciation options sparingly. Be sure to check with your tax accountant about the various requirements and conditions for using 179 expensing and the additional first year depreciation. Decisions about depreciation on new items placed in service during 2004 can be made up until the tax return is completed.
To avoid any unpleasant surprises, tax planning should also include an estimate of the tax liability due in March or April. While it is good to have adequate cash to purchase tax-deductible items by December 31, make sure there are enough available funds to pay the 2004 tax bill. It is better for you to pay taxes with available cash and borrow the funds necessary to purchase items for your business; interest on an operating loan is deductible on Schedule F, while interest on money borrowed to pay your taxes is not deductible anywhere.
Tax planning before the first of the year is always important to determine the projected net income of your dairy business for the current year. With that information, the manager can then make better decisions about what strategies are needed to better manage the tax situation. Be sure to check with your tax accountant to make sure what is best for your operation.