When Does Income Averaging Pay?

DTN Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen LLP in New Ulm and Minneapolis, Minn., and a national authority on agricultural taxation. He writes for both DTN and our sister publication, The Progressive Farmer. To pose questions for upcoming columns, email AskAndy@dtn.com.

QUESTION:

I read that income averaging would be more important for farmers in 2013 because we have higher tax rates. How do I know if this could benefit me?

ANSWER:

The commentary you read no doubt referred to the increased income tax rate that affects the top bracket filers. The new seventh bracket of 39.6% will hit those with over $400,000 of taxable income as single filers or $450,000 as joint filers. For farmers in that category, income averaging should be virtually automatic, as that higher-rate income can be taxed at lower rates that applied in the preceding three years.

Most filers whose income is over $200,000 in 2013 will see some tax increases, such as from phase-out of itemized deductions, phase-out of personal exemptions, or one of the two new taxes paying for the health care legislation. But all of these increases apply based on the size of the Adjusted Gross Income, or AGI, on page 1 of the Form 1040, or based on the earned income from wages or self-employment, and cannot be minimized with farm income averaging.

Sorting out the benefits of farm income averaging is best done by your tax preparer using sophisticated tax software. Most preparers do consider it carefully at the time of preparation of a farm return. My concern, however, is that we, as tax preparers, need to do a better job of considering the benefits of averaging at year-end tax planning time. When we advise on a target level of taxable income, it should take into account the magic of averaging. And in cases where one of the three base years is not ideal, there may be the opportunity to amend that base year first, so as to open up more "tax capacity" for income averaging. It may be possible, for example, to take a base year for the 2013 tax return (i.e., 2010, 2011 or 2012), and make an amended averaging election for that year, so as to push back some of its income in a way that frees up a better averaging result for 2013. Or perhaps a greater Section 179 first-year depreciation deduction can be claimed by amending a base year return. And don't abandon averaging if the Alternative Minimum Tax or AMT is in play. Even though that may look to be the prevailing tax, income averaging is still available to reduce the regular tax.

My advice is to query your tax adviser, during that year-end planning session, on how your prior three-year base looks for averaging, and make sure that all options are fully considered.

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QUESTION:

We have a local elevator that is using what they call a basis contract. The contract states that the selling farmer can collect 75% of the contract, but the other 25% is deferred until a settlement date that is after Jan. 1. Is the 75% portion of the contract included in taxable income in the current year?

ANSWER:

Farmers selling grain and other cash method commodities under a deferred payment contract have the protection of the installment sale method in the tax code. But even those rules do not protect from taxation on payments that may be constructively received or electively received during the tax year. A basis contract locks in the price differential between the commodity exchange price and the local delivery point, but defers the pricing decision for the commodity exchange price to a later date. Based on your description, I would conclude that the 75% portion (the amount which could be paid, if requested) is taxable because it is available at any time after delivery of the crop to the selling producer.

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QUESTION:

I would like clarification about a recent column you wrote on the new Patient Centered Outcomes Research fee for self-insured health plans. Is the $1 fee for this year based on the number of employees in the employer plan, or is it based on the total number of covered individuals, including family members of employees? If I am the wife/employee and am the only employee covered under the plan, but there are four family members in total in the plan, do we pay $1 or $4?

ANSWER:

Amazingly, the answer depends on the type of self-insured medical reimbursement plan that is used. A traditional Section 105 medical reimbursement plan must pay the PCOR fee on all lives under the plan. So if that is the type of plan that applies in your case, the amount due is $4. On the other hand, if your self-insured plan is a Health Reimbursement Arrangement (HRA), the fee is based on the number of employees participating, meaning a $1 fee in your case.

To identify the difference, you need to get into the details of the plan. A traditional medical reimbursement plan authorizes a specific sum that is a "use it or lose it" amount. In other words, there is no carryover of unused reimbursement authorizations into the next tax year. On the other hand, an HRA allows a carryover of unused amounts into the next tax year.

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