How to avoid common year-end tax mistakes

I always look for what clients are missing. At year-end, that might mean checking if the optional inventory adjustment is being used properly. For farmers working on a cash basis, this allows them to include income in the current year up to the total value of their inventory; so, if your inventory is worth $500,000, you can include $500,000 of extra income in the current year. The rest can be rolled over. This is useful if someone has invested in new equipment; it allows them to smooth their income out over time.

Planning for retirement can be another important topic at tax time. Farmers and farm families should develop a wind-down plan that accounts for their specific goals and, for those who might be taking over the business, setting them up. Consider the value of your equipment and what’s left in the depreciation pool. It’s tempting to go after the biggest write-off, but that’s not always the best thing for the long term.

Being mindful of farm structure is always important. There are benefits and drawbacks to incorporating. Just because a business might incorporate doesn’t mean everything in the farm – specifically land – must go along with it. It’s goal-dependent but retaining some personal ownership can be a good thing.

A lot of people aren’t using AgriInvest and AgriStability. AgriInvest allows farmers to invest 1% of their sales – after production costs are subtracted – into a government account. The government then matches that investment dollar for dollar, only taxing it once funds are withdrawn. It’s designed to help save money for difficult years, though is sometimes used as a savings account. I recommend producers discuss both stability programs with their accountant.

Align your tax management strategy to both personal and business goals – not the other way around. Target the level of profitability needed to achieve those goals. If the long-term goal is to maintain a certain level of profit, the amount of tax you pay should be enough to maintain sustainable cash flow and profits, while keeping a targeted balance sheet.

It’s important to consider tax strategies well in advance of year-end, particularly if a change in business structure is being contemplated. These changes often take months to co-ordinate. Get help from a trusted tax advisor to determine the proper facilitation of the right structure for both operations and asset holdings. The maturity of the farm, family member involvement, any entry or exit plans, and more should all be discussed.

Personal draws, where a farmer pays for something personally – rather than through tracked funds drawn from the farm – can be an issue in sole-proprietorships and partnerships. Whether financially significant or not, these can get lost since they’re generally not accounted for as stringently as in the company itself. At some point draws will be taxed. Basically, if you have taxable farm income on your personal return that’s less than personal draws, you’ve technically spent more than you earned. This can contribute to future cash flow and debt issues.

Land is an investment, not an expense. It requires tax-paid dollars to finance it, so if it’s purchased personally, those principal repayments – as well as the down payment – are funded with personal tax-paid funds. Whether the purchaser is an individual or company, planning helps ensure payments are feasible from a tax perspective.

Succession planning and changes in business structure are often not part of year-end tax discussions – but they should be. Planning for the future is just as important at tax time as the rest of the year. It can ensure farm families don’t miss important deduction opportunities.

Part of good planning might mean effectively using the $1-million lifetime capital gain deduction available to farmers when they sell or transfer qualified farm property; it bumps up the asset cost and will save taxes either now or on a future sale. Bear in mind if land is sold within three years, the parents may be paying taxes on the sale. It should also be noted that if a parent has passed away, the gains deduction can be claimed on their terminal tax return if it hasn’t been used already.

Depending on how many people are involved in the farm, it also makes sense to implement structures to manage potential disagreements in the future. Prenups can also help make long-term tax planning more stable and secure.

Paying children and other family members who work on the farm is another thing to consider. Especially for children, paying fair wages for what they do and providing a T4 helps them learn to budget, teaches life skills and reduces the tax burden on farm income.

You can devise a strategy that spreads your tax burden out over time – instead of a small tax bill one year and a large one the next. How you report and recognize your income for taxes plays an important role. Consider cash basis for tax and accrual basis for the banks. Accrual-based accounting provides a more accurate look at how the farm is doing year after year.