Most often self-employed individuals think of income tax management as using tools to minimize overall taxes paid. However, it is also important to think about managing taxable income in order to obtain Social Security benefit credits, be able to contribute to either a traditional or Roth IRA, or to claim the Earned Income Tax Credit (EITC), as well as various other benefits.
It is important to have enough farm earnings to obtain Social Security credits to qualify for retirement, survivor, and disability benefits. Farmers must pay self-employment tax in order to qualify for the benefits provided by social security.
To gain a quarter of old age (retirement) credit in 2019, earnings must be at least $1,360 for the year. Earnings must be $5,440 to get four quarters of coverage in 2019. In order to be fully insured for Social Security benefits, a farmer needs to have accumulated 40 quarters of coverage.
During periods when farm income is low, the farm optional method for paying self-employment tax can be used to obtain Social Security coverage credits.
For 2019, farmers with gross income less than $8,160 may elect to pay self-employment tax on 2/3 of their gross farm income and obtain Social Security coverage credit. If net earnings are less than $5,440, a farmer may elect to pay self-employment tax on $5,440 to get four quarters of Social Security coverage credits. This allows a taxpayer to earn four quarters of credits each year towards Social Security and disability eligibility.
A variety of income tax management tools are available that can be used to increase taxable income in years when income is low. The following items provide the opportunity to manage income tax after year end. These are simply elections that can be made which affect how much income is reported for the tax year and the remainder is carried forward to future tax years. Many more tools are available to manage taxable income.
Current depreciation rules provide farmers with a wide variety of methods to report depreciation for capital purchases such as machinery, equipment, draft, dairy, or breeding livestock, buildings, and fences, to name a few.
Depreciation of an asset can be taken completely in the year the asset is purchased and placed in service or can be spread over more than 20 years for farm buildings.
In low income years, slower write-off depreciation methods such as the straight line method allow for less depreciation being taken in the year the asset is placed in service.
The current tax law allows for the entire amount of the cost of an asset or group of assets to be written-off in the year placed into service. One hundred percent bonus depreciation allows for the cost of a group of assets with the same class life to be written-off in the first year.
The Code Section 179 expensing election allows for a depreciation deduction of up to $1.02 million of assets purchased in 2019 subject to a $2,550,000 total investment limit in depreciable assets.
In addition to depreciable assets, many farmers purchase fertilizer and apply it to crops annually. However the benefit of fertilizer often spans more than just one crop year.
The tax law allows farmers to elect to capitalize the cost and deduct it over two or more years depending upon the fertilizer’s beneficial life. By making this election, only a portion of the fertilizer’s cost is recovered in the year of application which reduces deductible expenses and thus increases taxable income.
Be sure to consult with your tax advisor to obtain additional information about income tax management provisions of the tax law that may be useful to meet your specific needs.
In addition, the Farmer’s Tax Guide, IRS Publication 225 for 2019, contains useful information for farmers to use when making tax management decisions.