With tax rates expected to climb, deferring payment may backfire

By MATEUSZ PERKOWSKI
Capital Press

When dispensing tax advice, ag accountant Clint Bentz would traditionally suggest that clients find ways to defer paying taxes on their earnings.

These days, however, he's telling clients to consider taking a tax hit as soon as possible, while the burden is still relatively low.

"We can pretty much guarantee tax rates will go up in the future," said Bentz, who is based in Stayton, Ore.

For example, provisions in the tax law allow farmers and other business owners to trade one investment property for another.

If the original property was simply sold, the farmer would owe capital gains taxes on the profit immediately.

When properties are exchanged, on the other hand, the capital gains taxes are deferred until the real estate is sold.

The capital gains tax is now 15 percent, but is set to go up to 20 percent after 2010 or potentially before, depending on decisions made by the Democrat-controlled Congress, said Bentz.

"That's a high-priority target," he said. "They're broke, and they need to raise revenue."

Farmers who have entered into such property-swap agreements -- known as 1031 exchanges -- have several options in terms of their tax debt, said David Moore, CEO of Equity Advantage, a company in Lake Oswego, Ore., that specializes in the process.

A property owner who wants to hold the real estate as a long-term investment should take a different view from the owner who is looking to sell it in the near-term, Moore said.

"People looking to cash out, today is maybe the day to do it," he said.

Farmers can other use techniques to defer paying taxes, such as paying for expenses in advance or delaying payments for delivered crops, said Tonk Fischer, an ag accountant in Salem, Ore.

Methods that reduce current-year taxable income need to be used carefully, considering the possibility of looming tax hikes, said Fischer.

"You have to take that long-term look," he said. "You want to balance out current tax savings with future tax liabilities."

Regardless of potential future tax increases, pre-paying expenses and postponing income can be dangerous for other reasons, said accountant Kerry Arritt, based in Burley, Idaho.

For example, if you deduct future expenses from this year's income, that will leave you with fewer deductions next year, he said.

If growers get in the habit of pushing income and expenses ahead every year, the amount of owed taxes can accumulate.

"It can become like a snowball if you're not careful," said Arritt. "It can build up on you. It's just building a mountain of future tax liability."

Besides, growers have other tools available to reduce their tax burden, said Bentz. Farmers can pay taxes based on their average earnings in the past three years, potentially allowing them to recover some of the money collected by the government in prior years, he said.

Growers who experienced a net operating loss can apply it to income earned within the past five years, which is another way to get back some previously paid tax dollars, Bentz said.

In light of the tough year many agriculture sectors experienced in 2009, this strategy may prove popular, Arritt said.

"I would think that to be an issue this year," he said.

Depending on how their businesses are structured, farmers have many creative ways to reduce tax burdens, Fischer said.

For example, hiring your spouse and providing her with health insurance can also reduce Medicare and Social Security taxes, he said.

Giving away a piece of fully depreciated machinery to your spouse and then leasing it back can yield an income deduction, he said.

However, growers need to remember that such strategies require careful attention to the rules -- the domain of accountants specialized in agriculture, he said.

"There's lots of places to save money on a farm," he said. "You just need to be aware of them."

Staff writer Mateusz Perkowski is based in Salem, Ore. E-mail: mperkowski@capitalpress.com.