I have written in the past about how the tax code contains special opportunities for farm tax returns that run in the red. With the ag economy continuing to suffer and with year-end tax planning coming up, it's time to take a deeper dive into utilizing these provisions.
LOSS CARRYBACK RULES
Generally, if a 1040 has a business loss that drives the return into negative territory, the net operating loss can be carried back two years (i.e., a 2016 tax loss carries first to 2014, then forward to 2015, and if large enough, onward to 2017, etc.). But if the loss arises from a farming business, a special five-year carryback applies.
For example, assume the 2016 1040 has $40,000 of salary income and a $240,000 Schedule F loss, for a net negative of $200,000. The loss carries back initially to the 2011 tax year, which for most producers was a high-bracket era. The loss works from the top down, offsetting the highest bracket income first. For example, if the $200,000 loss reduces the 2011 income from $300,000 to $100,000, it's reducing income ranging from the 33% to 25% brackets and generating perhaps a $60,000 refund. If the loss totally eliminates the 2011 taxable income, the excess then moves forward to 2012 and subsequent years.
You may electively decline the special five-year carryback, and instead use the general two-year carryback if it produces a greater tax benefit. Thus, that $200,000 loss in 2016 could be carried to 2014 if that was a higher bracket year. Taking a loss to 2014 could also make sense if combined with revocation of a large 2014 Sec. 179 deduction, effectively trading the 2016 loss for future depreciation.
AMENDING INCOME AVERAGING
Taking a 2016 farm loss back to reduce 2011 income is only the first step. The second is to amend 2013 and 2014 tax returns for an improved income averaging calculation. Income averaging looks to the prior three-year tax base to establish the rate for the year in question. The 2012 tax return is closed and can't be amended at this point, but 2013 and 2014 are open for amendment if the 2011 base year income is lower. The tax results can be eye-popping. In our example, that $200,000 tax loss not only harvests refunds from 2011, but knocks down the tax rate applicable to 2013 and 2014. Who knew a bad year after good ones could be so much fun!
The flexibility of the cash method allows you to move the needle dramatically on the amount of a 2016 farm tax loss. The challenge lies in analyzing the tax rate history and prior averaging computations now, to determine the optimum 2016 loss that maximizes tax recoveries from prior years. Your tax preparer has the software to do the "what ifs," and running that software is essential given the complexity of our tax system. You will need to work closely with your tax adviser to determine what makes sense at year-end both business-wise and tax-wise.
Editor's note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years' experience in ag taxation, including decades as a trainer for the American Institute of CPAs and other technical seminars. He will be presenting on this subject and other good tax habits at the DTN-Progressive Farmer Ag Summit Dec. 5-7 in Chicago www.dtnagsummit.com.
To pose questions for future tax columns, e-mail AskAndy@dtn.com.
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