Rutgers New Jersey Agricultural Experiment Station [Later Life Farming]

Module 9d: Strategies to Reduce Income Taxes

Federal and/or state income taxes are another "tax issue" that affects farm families, including the amount of earned income that is available to set aside for retirement. This module is divided into two sections: general tax reduction strategies available to all U.S. taxpayers and tax reduction strategies that are unique to farmers and self-employed workers:

General Tax Reduction Strategies

  • Contribute as much as possible to a tax-deferred employer 401(k), 403(b) or 457 plan if someone in the family has off-farm income. The maximum allowable deposit in 2009 is $16,500 and $22,000 for workers age 50 and over with an additional $5,500 catch-up contribution.
  • Contribute to a Traditional and/or Roth IRA; up to $5,000; $6,000 if age 50 and over (2009).
  • Hold assets for more than a year to take advantage of the 0% (for taxpayers in the 10% and 15% tax brackets) and 15% (for taxpayers in the 25% tax bracket or higher) tax rates on long-term capital gains. Note: these rates are set to expire at the end of 2010. Unless Congress passes a new tax law, the long-term capital gains tax rate will revert to 20% in 2011.
  • Consider purchasing municipal bonds or muni bond funds. Earnings are free from federal income tax and also escape state income tax if issued by a taxpayer's state of residence.
  • "Bunch up" deductions (e.g., charitable contributions), if their combined total is close to the standard deduction ($5,700 for singles and $11,400 for couples in 2009). This way you can itemize deductions, say, every other year and save more on taxes than if you didn't itemize.

Tax Reduction Strategies for Farmers and Self-Employed Workers

  • Take advantage of the Section 179 expensing election which allows business owners to claim an immediate tax write-off for new or used "tangible personal property" (e.g., a computer or farm machinery but not land or farm buildings or real estate) purchased for use in a business. The cost of qualified property is treated as an expense instead of a depreciating asset, which delays the tax benefits of a business purchase. In 2009, the Section 179 limit is $133,000.
  • Project the current and following year's income and expenses. Then, assuming you use cash-basis accounting, consult a tax advisor to determine the best timing for delivery and sale of commodities and/or prepayment of farm expenses to pay the least amount of tax possible.
  • Use farm income averaging to average the current year's taxable income with income from previous years' operations if it can lower your income liability. Typically, this is done when a farmer has a higher income in the current tax year than in previous (base) years and averaging results in a lower taxable income. Income averaging requires the use of a tax form called Schedule J which treats the election year (e.g., 2009) income as if it had been earned over the preceding three base years (e.g., 2006 to 2008) and taxed at their respective tax rates.

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