Farm Income Tax Management Chapter 16---Key Questions

1. Farm Income Tax ManagementChapter 16---Key Questions • What types of income are taxable? • What are the differences between income tax and self-employment tax? • What strategies can be used to maximize after-tax income?

2. Types of Taxable Farm Income • Ordinary farm income (Schedule F) • Federal income tax • State income tax • Self-employment tax • Capital gains income • Capital gains tax (lower rates)

3. IRS Schedule F Gross Farm Income • Farm Expenses (including depreciation) = Net Farm Profit • Can use cash or accrual. Most use cash.

4. Self-employment Tax • Up to $94,200 taxed at 12.4% for Social Security • All of it is taxed at another 2.9% for Medicare

5. Income Tax Deductions • Standard deduction • $5,150 for single person • $10,300 for married couple • Can itemize deductions instead • Personal exemption of $3,300 / dependent • Family of one has $8,450 tax free income • Family of 4 has $23,500 tax free income • Remainder is Taxable Income

6. Income Tax RatesFederal (married, joint) Taxable IncomeMarginal Rate • $0 to 15,100 10% • $15,100 - $61,300 15% • $61,300 – 123,700 25% • $123,700 - $188,450 28% • $188,450 - $336,550 33% • Over $336,550 35%

7. Iowa Income Tax Rates Increases gradually from ½ % up to 9% at $56,000

8. Example • Taxable income = $70,000 • 1st $15,100 taxed @ 10% = $1,510 • 2nd $61,300 – 15,100 = $46,200 @ 15% = $6,930 • 3rd $70,000 -$61,300 = $8,700 @ 25% = $2,175 • Total tax owed = $10,615

9. Tax Credits • Credits are subtracted from the amount of tax owed. • $1,000 credit for each child under 18 • $2,000 credit in 10% bracket could offset $20,000 of taxable income • Family of 4 could have $43,500 of taxable income without any federal income tax.

10. Marginal Tax Rates (last $)

11. Total Tax Rate

12. Capital Gains Income • When capital assets are sold for more than original tax basis • Taxed at 5% or 15% • Not subject to self-employment taxes • Breeding livestock • raised animals have zero basis, so all sales are capital gains

13. Individual Income Tax Return Farm income + wages, etc. - deductions and exemptions = taxable income x tax rates = income tax + self employment taxes + capital gains taxes - tax credits = total taxes

14. Tax Management Strategies 1. Level out income from year to year, avoid high marginal tax brackets • Example: Taxable Income Fed Income Tax • year 1: $ 90,000 $16,000 • year 2: $ 10,000 $ 1,000 • $17,000 • Level income: • year 1 $ 50,000 $ 6,800 • year 2 $ 50,000 $ 6,800 • $13,600 • Saving $ 3,400

15. 2. Defer income into future tax years, earn interest on tax $ $30,000 x 25% tax rate = $7,500 $7,500 x 8% interest rate = $600 • Use cash accounting to: • Delay income • Move up expenses • Use fast depreciation rates

16. Tax Management Strategies 3. Report enough income to use up personal deductions and credits 4. Qualify income as capital gains when possible 5.Use net operating losses (NOL) to offset past taxes 6. Use income averaging (back 3 yrs)

17. Goal of Tax Management Maximize long-run income after taxes, not minimize taxes.