2004 Income Tax Issues Laws applicable to livestock

2004 Income Tax Issues Laws applicable to livestock producers. Oklahoma State University

Tax Management Objectives • After tax profit maximization - general objective • Must consider tax as a cost, like any other cost of doing business • Minimizing taxes can result in overinvestment • Tax management = minimum legal tax

Tax Management Concepts • • • Depreciation = method of allocating cost Tax vs management Depreciation is a deferral MACRS fixed life, fixed method 1/2 year in year of purchase or sale – Except 40% rule mid-month convention • Section 179 expense election

New Depreciation Options • MACRS (Modified Accelerated Cost Recovery System) – GDS (General Depreciation System) – ADS (Alternative Depreciation System) • 30% Additional First-Year • 50% Additional First-Year • Sec 179 Expensing Election

30% Additional First Year • Rules – Applies to MACRS Property with Class Life of 20 years or less – Original Use after Sept 10, 2001 (must be new property) – Purchased between 9/10/01 and 1/1/05 – Placed in Service by 1/1/05

50% Additional First Year • Rules – Applies to MACRS Property with Class Life of 20 years or less – Original Use after May 5, 2003 (must be new property) – Purchased between 5/05/03 and 1/1/05 – Placed in Service by 1/1/05

What is New? • Never placed in service by anyone else (original use by taxpayer) • New Cow - original use applies to owner when she has her first calf. • New Bull - original use applies to owner when he is used as a sire.

Section 179 Expense Election • Purchased capital assets - depreciable • Fixed life: 5, 7, 10, 15, 20, 27. 5 years • Up to $100, 000 current depreciation expense ‘ 03, ‘ 04 & ‘ 05 ($25, 000 in ‘ 06) • Must not create a loss • Treated as depreciation subject to recapture • Pickup GVWR > 6000 allowed

Tax Management Tools To Level Income • • Cash method of accounting Accelerate taxable income or expenses Pre-paid expenses up to 50% Depreciation straight-line, accelerated Income averaging Net operating loss Carryback 5 years Net operating loss Carryforward 20 years

Income Averaging for Agriculture • • Use Schedule J, Elected Farm Income Schedule F, capital assets not land Individual, Partner, & S Corp Shareholder Not C Corporation, Estate, or Trust, Elect any part or all farm income Spread equally over last 3 years Pay increase in income tax only Does not change SE Tax or NOL

Net Operating Loss • • • 1997 Net Operating Loss farm or business Carry back losses to previous 2 tax years Carry forward losses for 20 future years 1998 Special Farm Rules allow losses Carry back 5 previous tax years Could generate immediate tax refunds

Tax Basis Purchase, gift, or inheritance? • Purchase = Cost • Adj basis = Cost - depreciation • Gift = Donor’s tax basis • Inheritance = Fair market value (date of death)

Recapture vs Capital Gain • Purchase cow – $500, 5 year life, straight line depreciation ($100/year) – After 2 years, adjusted basis = $300 • Alternative sale prices, tax implications – Sale price $300, no gain or loss – Sale price $400, $100 recapture ord. income – Sale price $600 • $200 recapture ordinary income • Capital gain = $100, marginal rate 5% or 15%

Capital Gain Land, machinery, breeding livestock • Sale price in excess of purchase price • 5% capital gain tax rate for 10 % and 15% tax bracket (0 in ‘ 08) • 15% capital gain tax rate for 25% bracket and above • Tax shelters: Raised breeding livestock – Current deduction = cost of raising – Capital gain on sale

Weather Related Sales of Livestock • • 1997 Taxpayer Relief Act Any weather related, not just drought Eligible for Federal assistance Declared by Secretary of Agriculture

Tax Benefits of Weather Related Sales • Choices for sales greater than normal only – Postpone gain by replacing breeding livestock within a 2 -year period – Postpone reporting gain one year for any type of livestock

Replace Breeding Livestock within 2 Years • Gain on sales in excess of normal sales • Weather must have caused sale • Make the election • Compute the gain • Replace within 2 years

Replacement Requirements • • • Replace within 2 years of drought sale “Like kind” as well as “like use” At least as many cows At least as many dollars If not, must file an amended return for the year of drought sale • Pay tax and interest due

1033(e) - Postpone gain, repurchase same type of animal within 2 years

Report Gain Next Year • Applies to any livestock • Sales in excess of normal • County declared eligible for Federal Assistance • Compute gain same as above • Make election to postpone • Pay tax next year

451(e) - Election to defer income to next tax year Example 2004 2005 Sell animals. Pay Sell animals. tax in next year. Defer gain from excess sale to next year. Report sale of animals on ’ 01 return. Sell excess “breeding “animals in ’ 02 with 451(e) election; decide to replace Decide to replace breeding animals Sell excess animals. Report gain on sale of excess animals. Amend ’ 02 return to show 1033(e) election. Repurchase cows. 2006 Repurchase cows.

Elect to Postpone One Year Then Change Your Mind • Can request permission to replace in two years Original election to replace in two years CANNOT CHANGE! CONSIDER WHICH ELECTION CAREFULLY. . .

Computation of Gain • Cash, Shirley normally cull 8 cows • This year 16 culled due to drought and sold for $300 • 8 cows @ $300/hd = $2, 400 gain postponed

Tax Basis in Replacement Cows • If buy 8 cows for $2400, new cows have no basis. Tax postponed until new cows sold. • If buy 7 cows for $2100, new cows have no basis. Amend and pay tax on $300 one cow not replaced. • If buy 8 cows for $3200, new cows have $100 tax basis each. Tax postponed until new cows sold.

Financial, Tax Planning & Management • • • Year-round every day job Basic knowledge required Know when you don’t know “What if” rather than ‘this is what I did’ Professional advice Year-end tax planning

Good Records Win • • • Required for tax and financial reporting IRS, Bankers, PCA, other lenders Schedule F - Taxable income & expense Progressive tax rates Income leveling, form of business organization • Defer tax, tax - free exchange • Net Operating Loss forward 20 years, back 2 years

Questions? The end!