Larimer & Boulder Counties, Colorado 2008 December 17 th

1. Larimer & Boulder Counties, Colorado 2008 December 17th

2. Jeff Tranel • Agricultural and Business Management Economist • Ranch raised • Colorado State University • Extension • Department of Agricultural & Resource Economics • jtranel@colostate.edu • www.coopext.colostate.edu/tranel • I am not a Certified Public Accountant

3. Income Taxes • Congress alters tax code periodically • Tax Court rules on tax issues • Can often be interpreted in multiple ways • Income tax codes and regulations are complex. Please consult with your tax practitioner about application of tax codes and regulations.

4. What Are Your Goals? • To make money • Short term? • Long term? • Taxes • No taxes? • Minimize taxes? • Pay more taxes every year? • Equity (net worth) • Maintain? • Increase? “A farmer will never go broke paying taxes” - Anonymous Farmer

5. Your Goals ExxonMobil Taxes = $61.7 million ExxonMobil After tax income = $22.6 billion

6. Definition of a Farm

7. For Profit Farming • It is a business if there is net income or profit in three of last five years • Activities consisting of breeding, showing or raising horses, it is a business if there is a profit in two of last seven years

8. Intent to Profit • Farming for profit • Operate in business like manner • Time and effort • Depend on farming for livelihood • Losses due to circumstances beyond your control • Change operation in attempt to increase profitability • Have necessary knowledge • Past success • Profits earned in some years • Expect profits in future years

9. Hobby Farming • Definition • Profit is not primary motive • Farm income not primary source of income • Tax Implications • Limit on deductions • Cannot use loss to offset income from other activities • Report income on Form 1040 and deduct expenses on Schedule A (Form 1040)

10. Qualified Farmer? • 2/3 of Gross Income • must come from farming/ranching in current or prior year • Gross Income = All Income • Farm Income = Income from Farming/Ranching (Schedule F) + Gross Farm Rental Income (Form 4835) + Gross Farm Income (Schedule E, Parts II & III) + Gains from Sale of Breeding Animals (Form 4797)

11. Material Participation

12. Material Participation • Regularly and frequently makes, or takes an important part in making, management decisions. • Works 100 hours or more spread over a period of 5 weeks or more. • Does things that, considered in their totality, show material and significant involvement. • Does any three of the following: • Pays half • Furnishes • Advises or consults • Inspects

13. Material Participation • Income and deductions from farm rentals, including government payments received by the landowner, are subject to self employment (SE) tax, if: • Sell, exchange, give away, or use the crop shares • Materially participate at the time the crops are produced

14. Importance of Records

15. Records • Meet the needs of: • You • Lender • Tax preparer • Other • Are required by the IRS to be kept for 3 years after date of filing • 7 years in cases of suspected fraud • Applicable years regarding capital assets

16. Farm Income

17. Farm Income • Sales of livestock and other items purchased for resale • Sales of farm products purchased for resale • Profit or loss is the difference between the basis in the item, usually the cost, and any payments received • Basis may have been carried forward from a previous year • Sales of livestock, produce, grains, and other products raised • Sales of all raised products

18. Farm Income Agricultural Program Payments • All agricultural program payments, including CRP payments • Even if a government check was returned for cancellation or the government collects all or part of the payments by reducing the amount of another payment or CCC loan • The government should send the taxpayer a Form 1099-G indicating the total amounts received Crop Insurance Proceeds • Proceeds from insurance on growing crops • Included in gross income in the year actually or constructively received.

19. Farm Income Crop Insurance Proceeds • Proceeds from insurance on growing crops • Included in year actually or constructively received • Can be postponed until following year if: • Use cash method of accounting • Received insurance proceeds in same tax year as crops damaged • Normal business practice to sell crop in following year

20. Farm Income Other Income • Items that generate income during the year. • Crop share rents • Breeding fees • Sales of soil • Items not included in other sections of farm income.

21. CRP Payments • Before • If actively farming, active income (Sch. F) • If not actively farming, passive income (Sch. E) • Now • By complying with terms of CRP contract, you are actively farming • CRP payments are considered “government payments” not rental payments • After 2007 • If receiving Social Security benefits (retirement or disability) • CRP payments are excluded from self-employment income

22. Hedging as Risk Management • Hedging transactions entered into in normal course of business • For risk management purposes • As forward contracts, futures contracts, options • Commodity is produced on the farm or directly affects the business • Generally an ordinary gain or loss • Reported on Schedule F

23. Hedging as Speculation • Hedging transactions entered into which are not part of the ordinary business of farm • Has specific record keeping requirements • Reported on Form 1040

24. Farm Expenses

25. Farm Expenses • Ordinary and necessary costs of operating a farm or agricultural enterprise. • Capital improvements increase basis of applicable assets. • Depreciation reduces basis. • Expenditures for purchases of items for resale are not deductible in year occurred (under cash method).

26. Car & Light Truck Expenses • Must be able to prove deduction for travel with adequate records or other evidence. • Example: account book supported by things such as expense receipts • Not deductible for commuting miles • Depreciation limited (if placed in service in 2007) • $3,060 in 1st year • $4,900 in 2nd year • $2,850 in 3rd year • $1,775 in 4th and later years • $25,000 max depreciation-for SUVs See Publication 946. Limits are higher for light trucks, vans , and electric vehicles. Assumes 100% business use.

27. Car and Light Truck Expenses • Up to 75% • Directly in connection with farming • In first year the vehicle is placed in service • Cannot change to another method at later time • 100% • Must have records of proof • Must be used for business the percentage that is claimed

28. Car and Light Truck Mileage • Standard mileage rate • $0.505 in 2008 (Jan 1 – Jun 30) • $0.585 in 2008 (Jul 1 – Dec 31) • Business miles only • Not deductible for commuting miles • Cannot be used if operating 5+ cars and light trucks at the same time • Business rate in 2009 = $0.55

29. Prepaid Livestock Feed • Deduct the cost of livestock feed to be consumed in a later year if (meet all tests) • Deductions for prepaid livestock feed may be limited to 50% of other deductible farm expenses

30. Prepaid Livestock Feed 1. Payment is for the purchase of feed rather than a deposit • Specific quantity • Fixed price • Not entitled to refund or repurchase • Would be considered a deposit if: • Absence of specific quantity terms • Right of refund of any unapplied payment credit • Right to substitute other goods or products • If there is a provision in a binding contract permitting substitution of ingredients to vary particular feed mix to meet livestock’s current diet requirements will not suggest a deposit

31. Prepaid Livestock Feed 2. Prepayment has a business purpose and is not merely for tax avoidance. • Reasonable expectation of receiving some business benefit for prepayment • Examples • Fixing maximum prices • Securing assured feed supply • Securing preferential treatment in anticipation of a feed shortage

32. Prepaid Livestock Feed 3. Does not materially distort income. • Customary business practice • Expense in relation to past purchases • Expense in relation to income for the year • Time of year

33. Prepaid Livestock Feed Summary for deduction of prepaid livestock feed: • Payment is for feed, not a deposit • Payment has business purpose, not for tax avoidance • Prepayment does not materially distort income

34. Wages for Labor • Deduct reasonable wages • Use fair market value of any assets given to hired labor • Deduct as farm expenses the costs of boarding farm employees • Issue Form W-2 for all employees

35. Contract vs. Employee Labor • Entered as “custom hire” • Cost must be capitalized • “20 Factors” • Individual contractors receiving more than $600 must receive a Form 1099-MISC

36. Hired Labor- Family Members • Deduct reasonable wages and other compensation paid your child • Deduct reasonable wages and other compensation paid your spouse

37. Prepaid Farm Supplies • Amounts paid during the tax year for feed, seed, fertilizer, and similar farm supplies • Must use cash method of accounting • Limited to 50% of other deductible farm expenses

38. Prepaid Farm Supplies Exceptions to the 50% Limit: • Does not apply to farm-related taxpayers if: • Business operations changed due to unusual circumstances • Total prepaid farm supplies in preceding 3 years is less than 50% of total other deductible farm expenses in those three years

39. Business Use of Home • Can deduct expenses for business use of home if part of the home is used exclusively and regularly • Deduction limit applies • Any depreciation taken reduces the home’s basis

40. Business Use of Home - Telephones • Cannot deduct cost of basic local telephone service for the first telephone line into the home • Can deduct: • Business long-distance changes on the first line • Cost of second telephone line into the home if used exclusively for farm business

41. Depreciation • Annual deduction recognizing that assets wear out or become obsolete • Types of tangible property • To be depreciable, property must meet conditions • Records of depreciation on capital assets must be kept by the taxpayer

42. Depreciation • To be depreciable, property must (meet all tests): • Be owned • Used in the business or income producing activity • Have a determinable useful life • Be expected to last more than one year • Most types of tangible property. • Buildings • Machinery & equipment • Vehicles • Livestock • Fences • NOT land

43. Depreciation

44. Depreciation

45. Depreciation – Breeding Livestock • Raised breeding livestock: • Not typically depreciated • Incurred expenses deducted as ordinary farm expenses • Have no basis when sold • Sale price less selling costs equal capital gains

46. Depreciation Limits • Limits • Passenger automobiles of < 6,000 lbs (GVW) • Entertainment and recreational property • Computers • Cellular telephones • Generally, most assets that lend themselves to personal use

47. Depreciation – Section 179 • Allows deducting all or part of qualifying property in the year “placed in service” • Qualifying property • Property must be used more than 50% for qualified business use

48. Depreciation - Section 179 • Allows deducting all or part of qualifying property in the year “placed in service”. • Qualifying property: • Purchased for business use • Personal property, ag fences • Single purpose ag structures • Does not include real property • Property must be used more than 50% for qualified business use. • Limits in 2008 • Apply to individuals • $250,000 for married couples filing jointly (MFJ) • Reduced as total cost of all qualifying section 179 property placed in service within the tax year exceeds $800,000

49. Depreciation – Example 1

50. Depreciation – Example 2