As farmers prepare to meet with their tax consultants in the next few months, they should consider input costs for next year, know tax laws on leasing equipment, and separate their income goals from activity in hedging and speculative contracts, farm tax specialists told Agriculture Online this week.

After determining their historical income level, tax planners work on what the farmers' goals are and where they want their income levels to be.

Tax planners urged farmers to strive for consistency in their income. Farmers can defer income at the end of the year by deferring prices on their grain stored at the elevator, and deferring payment from the federal commodity credit loans.

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Daryl Kruse, Iowa Farm Business Association tax planning consultant, said huge crops in 2004 and 2005 increased incomes, making pre-tax planning even more important.

"Farmers need to be consistent from year to year, not letting their income fluctuate," Kruse said. "To do this, farmers are urged to delay sales or have additional expenses by pre-paying or contracting the next year's supplies."

Kruse added, "When they contract those supplies, there has to be a definite quantity specified. A receipt is needed for those purchases. "You just can't go in to your local crop production supplier and give them a check for 'x' amount of dollars and not specify what it's for."

Kent Meister, a tax planning and financial consultant with the Illinois Farm Business Association, agreed the input costs of 2006 could be the biggest tax consideration for farmers.

"For tax planning purposes, farmers need to keep in mind those input costs are going up a lot," Meister said."

One aspect farmers tend to neglect when it comes to tax planning is the revenue made from marketing through hedging and futures contracts.

Because income from futures contracts can be collected in different months of separate years, pre-tax planning and marketing are related.

For instance, farmers with paper profit on December 31 from any speculative futures contracts are required to pay taxes on that income. Plus, any losses from a futures contract are recorded at the end of the year.

Meister said tax laws for hedging contracts are different. "Any hedging contracts are carried through until those hedges are carried out to their completion," Meister said. "A hedging contract is not taxable until it's finished."

When asked about other tax issues farmers need to be aware of, Kruse pointed out farmers seem to be misinformed on machinery lease contracts.

A true lease is defined as being given the right to use something, for a certain time period.

However, what some equipment dealers and financial institutions offer is not seen as a lease by the IRS, Kruse said. "The confusion starts when a 'lease' agreement states the farmer pays 'x' amount of dollars for so many years and the farmer will own it at the end of the agreement," Kruse said. "IRS typically views this as a purchase contract not a lease."

If an interest rate is involved, or if the buyout of the equipment is less than fair market value, it is important for producers to remember that the equipment purchase cost will be deducted as depreciation, and items may be eligible for the $105,000 section 179 quick write-off in the initial purchase year.

Simply stated, the producer will get to deduct the purchase cost as depreciation if purchased or can deduct the lease payments if leased.

The tax planners urged each producer to discuss the tax impact of acquiring capital assets with their tax consultant prior to purchasing the asset to ensure it is the correct decision for their operations.