Tax year 1991 is over for most farmers, but tax returns still need to be filed. There are still a few decisions which may impact taxes for 1991 and future years. Farmers may also want to consider whether different procedures of paying labor and obtaining health insurance might result in tax savings in 1992 and later years.

Section 179 Expensing

The recently proposed regulations clarify what sources of income are considered in determining the taxable income limitation for Section 179 expensing. Under Section 179, up to $10,000 of qualifying assets purchased during the year may be deducted instead of being depreciated. For a farmer, the net profit or loss from the Schedule F is combined with several other sources of income to determine the taxable income limitation. The net Section 1231 gains or losses, generally reported on Form 4797, and the individual’s share of partnership and/or S corporation tax­able income are included. Salary and wage income received by the farmer and/or spouse and other business income are also included in determining the Section 179 income limitation.

For example, assume that a farmer has a loss of $12,000 on Schedule Fin 1991 and a gain of $2,000 reported on Form 4979 from the sale of assets used in the farm operation. The farmer has net income of $1,500 from seed corn sales and the spouse has $17,500 wages from an off-farm job. The couple would have a total of $21,000 income for various sources minus the $12,000 Schedule F loss, or $9,000 of income for the Section 179 expensing. Thus, up to $9,000 of qualifying assets purchased in 1991 could be expensed.

Farmers whose incomes were low in 1991 may want to forgo Section 179 expensing. The expanded definition of taxable income for Section 179 purposes may allow some income tax savings, but the self-employment tax effects should also be considered. By not expensing 1991 capital purchases, a farmer will have larger depreciation deductions in I 992 and later years. These larger deductions reduce income for both income and self-employment tax purposes.

Final Quarter Limitation

If more than 40% of all assets acquired during the year are acquired during the last three months of the tax year, the mid-quarter convention (rather than the mid-year) convention is used for all assets acquired that year. However, the 40% test is made after any Section 179 expensing is used. This is a change from interpretations made prior to the proposed IRS regulations released in March 1991.

Depending on individual cir­cumstances, use of Section 179 expens­ing may increase or decrease the amount of regular depreciation. For example, if a farmer bought a $15,000 drill in March and a $20,000 planter in December, the final quarter limitation would apply. Using the mid-quarter convention, depreciation would be $3,348.50 (18.75% x $15,000 plus 2.68% x $20,000). This is less than the $3,748.50 depreciation with the mid­year convention (10.71 % x $35,000) which would have applied if the planter had been purchased before October. If one elected to use Section 179 of $10,000 on the planter, less than 40% of the assets would have been acquired in the final quarter and the mid-year convention would apply. Depreciation would be $2,677.50 (10.71 % x $15,000 plus 10.71% x $10,000) plus the $10,000 Section 179 expensing.

Careful election of the assets to be expensed and the amount of expensing may have a substantial effect on the amount of depreciation which may be taken in a year.

Depreciation Alternatives

Farmers may elect to use slower methods of depreciation for assets acquired in 1991. Use of straight-line depreciation over the 7-year MACRS class life or the JO-year optional period for most agricultural machinery will reduce the depreciation deduction in 1991. This might help avoid a loss situa­tion for 1991. Larger depreciation deductions will be available in future years when income and earnings from self-employment may be higher.

Net Operating Losses

Farmers who have net operating losses (NOL) in 1991 have some tax management alternatives. An NOL arises when expenses on Schedule F exceed farm receipts and other income. A 1991 NOL is carried back for three years, to 1988, unless a farmer elects to carry the NOL forward to reduce taxable income in future years. Carrying an NOL back may result in a refund of income taxes paid, but there is no effect on self employment taxes paid.

The election to forgo the NOL car­ryback must be made by the due date of the NOL year tax return by attaching a statement. As with the NOL carryback, carrying an NOL forward to 1992 will not reduce future self-employment tax liability.

Noncash Wages for Agricultural Employees

Payment of agricultural workers in farm commodities rather than cash has been popular with some farmers. Under current law, neither the employer nor the employee is subject to social security taxes on these noncash wages. There is no self-employment tax on the sale of commodities by the employee. However, payment in noncash wages does not qualify the individual for benefit coverage by the Social Security Administration.

The IRS has served notice that they will examine transactions involving noncash wages carefully. It is a good idea to have a written employment contract detailing the duties of the employee and the rate and form of pay­ment in units of the commodity. If use of the employer’s facilities, such as a truck, grain bin, or feedlot is involved, the employment contract should either set a ren􀀩al rate which the employee pays or indicate that the free use is part of the employee’s compensation. Any rent-free use should be treated as addi­tional noncash compensation and included in the employee’s wages for income tax, but not for social security purposes. Treatment of facility use should be consistent on both the employer’s and employee’s tax returns. Finally, it is important to show that the employee has “dominion and control” of the commodity before it is sold. For arrangements involving spouses, proceeds of the sale of the commodity by the employee should be deposited in an account which is not used to pay the farm expenses.

Health Insurance

Congress extended the income tax deductibility of 25% of the cost of health insurance for self-employed individuals through June 30, 1992. A qualifying individual may deduct 25% of the cost of the family’s health insurance as an adjustment to income, but not as earnings from self-employment.

Employers may generally provide tax deductible health and accident insurance to their employees and such insurance is not taxable income to the employee. (Special rules apply to employee-shareholders of S corpora­tions.) A farmer who is sole proprietor may provide tax deductible health and accident insurance coverage to his or her spouse who is employed on the farm. Furthermore, the farmer may be covered by the insurance as a family member of the employee. It is important that a true employer/employee relationship be established. The farmer employer is not required to provide health and accident insurance to all farm employees.