In a year in which cattle profits are way down, your tax bill may be another kick in the pants.

That’s because income deferred when disastrous drought forced herd liquidation four years ago could heavily increase this year’s federal tax burdens, says James Tate, CPA, an agricultural tax specialist with Tate & Cox PC, Amarillo, Texas.

“It’s insulting for anyone to be losing money and still have to pay taxes,” Tate says. “However, you can easily get into that situation if breeding stock liquidated due to drought have not been replaced with breeding stock of equal or higher value within the time period specified by federal tax laws.”

These and other tax laws that relate to cattle production and farm or ranch management illustrate the importance of extensive tax planning. It’s needed to ensure that an unforeseen tax burden doesn’t cause end-of-year shock. 

Tate and other ag tax accountants say there are pitfalls like noneligible prepaid feed, financing and ill-timed receipt of payment that can hurt producers and feeders financially if they’re not careful. Here’s a look at some tax-time considerations:

Deferred income

This is common in the cattle business. “Some joke that ‘If you’re in the cattle business, you don’t have to pay taxes,’” Tate quips. “But if you sell cattle, then defer that income, you eventually have to pay taxes on it. That’s the case with the drought-sold cattle.”

The deferred income caused by drought likely impacted some producers last year and may impact more in 2016. With devastation caused by drought years 2011, 2012 and beyond for some, hundreds of thousands of cows and bulls were sold for slaughter, or to ranchers where the grass was greener. To aid ranchers from having to declare unexpected windfall, the IRS allowed them to defer that income up to four years.

“If you’re just looking at your current bank statement, you’re probably not going to see that deferred income,” Tate explains. “But that income will figure into the amount of tax owed the government if replacements have not been purchased.”

He says deferred income and replacement cattle costs are on a dollar-for-dollar basis. “For example, if a rancher deferred $100,000 in income from liquidated breeding stock, he must spend at least $100,000 in breeding stock to offset that,” he says.

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“With higher-priced bred heifers, cows and bulls, that cost to replace an equal number of breeding stock is likely higher. In that case, if, say, $150,000 to $200,000 was spent to replace liquidated cattle, the amount over the $100,000 will be eligible for deduction as depreciation.”

No Santa surprise

For several years, Congress waited until nearly Christmas to expand the IRS Section 179 tax deduction limit. It forced some to wait until late December to buy new tractors, trucks and other equipment.

“But late last year, legislators approved setting the maximum tax deduction at $500,000 for equipment and some other assets bought during the calendar year,” Tate says. “That helped in tax planning. Fortunately, there are no pending tax law changes at the end of the year.”

IRS says the Section 179 deduction provision is good on new and used equipment, as well as off-the-shelf software. The equipment must be financed, purchased and put into service by the end of the day Dec. 31, 2016.

The spending cap for purchases is $2 million before the Section 179 deduction that’s available begins to be reduced on a dollar-for-dollar basis. There is also 2016 bonus depreciation of 50% for new equipment. “It is 50% of the acquisition cost of equipment,” Tate says.

“I encourage producers and feeders to not base buying new equipment on whether there is a tax deduction. But if new equipment is needed, time the purchase to provide the best tax effect.”

He points out that another added benefit is the ability to deduct prepaid rent costs for land used for ag production. “Prepaid rent was excluded in previous tax years,” Tate says. “Now, up to one year of prepaid rent it can be deducted when paid.”

Prepaid feed?

IRS often doesn’t like the taste of prepaid feed deductions, Tate says, and “would like to catch people” using it the wrong way.

“In IRS rules, there must be an actual purchase of the commodity,” he says. “You have to own the corn or other feedstuffs by the end of the year. It doesn’t have to be in your possession, but you have to own it.”

In addition, if a producer or feeder finances prepaid feed with the same person or entity they’re buying it from, “it is not considered paid by the IRS,” Tate says. “That’s why you see separate finance companies within a number of operations.

“Make sure the company you’re buying feed from has a separate finance subsidiary. IRS could even question whether that is within the tax code. There is no clear answer on that question,” he says.

“The cleanest way is to have a bank finance it for you. Also, if a feedyard carries feed bills for you until cattle are sold, you might want to send them a check for that feed at the end of the year. Feed costs are not deductible until they are paid.”

Constructive receipts

Yet another pitfall is the concept of “constructive receipts.” In IRS terms, “Income is constructively received when an amount is credited to your account or made available to you without restriction.”

“If an agent [such as a feedyard] receives payment for you, it is the same as if you received payment,” Tate says. “If that constructive receipt is made before midnight Dec. 31, it cannot be deferred until the next year.”

Producers and feeders can avoid this and other IRS problems if you have a solid tax plan in place, along with your estate plan. “If you do it right the first time, you can avoid surprises,” Tate concludes.

Larry Stalcup is a freelance writer based in Amarillo, Texas.

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