Year-end tax planning affected by new tax laws
The Small Business Jobs Act signed by President Obama in September has three important implications for farmers' year-end tax planning.
1. Faster equipment write-offs. Before passage of the bill, the maximum amount that could be expensed in 2010 (the Sec. 179 expense allowance) was $250,000. The Act raised the limit to $500,000 for both 2010 and 2011. The Act also reinstated (for 2010 only) the 50% bonus depreciation. So you can take the bonus depreciation on what you don't expense.
Example 1: Farmer Smith purchases $700,000 worth of machinery in 2010. He can elect to expense $500,000. The remaining $200,000 is eligible for the bonus depreciation, in this case $100,000. Depreciation in 2010 on the remaining $100,000 would be $10,710. Hence, the total write-off in 2010 for the new purchases would be $610,710. Of course, if he takes the expense election and bonus depreciation, his depreciation for 2011 on the machinery will be smaller, in this case only $19,130.
Most farmers will have pretty healthy taxable incomes in 2010. If you have had a bad year, however, you don't need to use either the expense allowance or the bonus depreciation. You must elect to use the expense election and elect not to use bonus depreciation.
Example 2: Assume the same facts as in Example 1, except that Smith decides not to use the expense allowance or the bonus depreciation. His write-off in 2010 would be $74,970 ($700,000 x .1071). In 2011 his depreciation would be $133,910 ($700,000 x .1913).
The expense election and bonus depreciation rules are different for acquisition of used assets. The expense election may be used on used assets; however, bonus depreciation is limited to new assets.
In order to take the expense election or depreciation, you must have placed into service the machinery or equipment by year-end. But "placed into service" doesn't mean that you actually have to have used the machinery, just that the item be ready for use.
Example 3: Smith purchases and has delivered to him a new combine by late December of 2010. The combine is ready for use. Even though he doesn't do any harvesting until 2011, the combine is considered placed into service in 2010.
2. Health insurance deduction. For 2010 only, you can deduct health insurance from your self-employment income to determine your self-employment tax.
Example 4: Smith, farming as a sole-proprietor, has self-employment income in 2010 of $60,000. He paid $9,000 in health insurance premiums for his family. His self-employment tax is $7,206 ($51,000 x .9235 x .153). If the year were 2011, his self-employment tax would be $8,478.
Tax Tip: If possible, consider prepaying your January premiums in December. Prepaying a $750 health insurance premium could save you $106 of self-employment tax.