Farmers have many factors to consider in order to run their operations successfully. One of the main factors that must be carefully planned is the effect taxation will have on the operation of their business.
We at Farmgate advisors want to help farmers manage their business by providing good tax strategies and information. The following information is just one of the planning tools that will help your farm operation save tax dollars.
Mandatory inventory adjustment is required when a farmer has a net loss for the year. If this occurs the farmer must add the value of their purchased inventory to their income at market value. Purchased inventory consists of livestock, feed, fertilizer, and chemicals, not including feed or livestock that you have raised yourself. It does not matter if this inventory was purchased in the year, or carried forward from other years, which often is the case with breeding animals.
If this inventory is on hand at the end of the year, it must be valued at the low end of fair market value, and then add the total amount into the farm income.
An example of MIA is if a farm loss was $20,000.00 and farm purchased inventory totals $15,000.00 the loss would be reduced by $15,000.00 to $5,000.00. The result of this, is that the farm loss is reduced to $5,000.00 instead of the $20,000.00 actual loss. The difference of $15,000.00 (MIA) can be deducted from farm income the following year.
Optional adjustment is a tool that farmers can use to average their income and prevent large fluctuations from one year to another.
It is first used in a lower income year to increase income which will allow basic tax exemptions such as spousal exemption, disability credits, medical and donation credits, tuition, and age exemptions to be used. Most of these credits are lost and cannot be carried forward. Optional adjustment allows any amount up to the fair market value of farm inventory to be added to the yearly income.
Unsold inventory is included in the low-income year along with the basic tax exemptions, then the unsold inventory can be deducted in year two. This process can be repeated from year to year until the income is high enough that adjustment is no longer advantageous.
A farmer can also use this adjustment to bring up their income to the top of the low tax bracket (approximately $40,000.00) if in the next year the income is in a higher tax bracket. Implementing this process can result in saving up to 14%, which can be more beneficial than carrying a loss forward.
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