Have you ever wondered when you will need to start thinking about tax planning before you retire? That might be on your mind as you get closer to transitioning your farm to the next generation.
The answer depends on how you've taken advantage of tax deferments. Here's a scenario we often see: The farmer pays his expenses ahead each year in order to reduce the amount of profit he'll be taxed on in that given year. He may also push his income from grain sales into the next calendar year. This helps him manage his current taxes because he's always pushing them into the next year.
If it makes business sense for your operation, it's a way to manage your tax liability. But what happens when the farmer wants to retire? What's his last tax bill before retirement going to look like?
If he doesn't plan in a proactive way, that bill could show a lot of income – maybe several years of grain sales – with little or no expenses to balance things out. The tax debt might not leave him with the income he'd anticipated for his retirement.
Starting early on your legacy plan – and including tax planning as part of your strategy – lets you take control of what that tax bill will look like. Most farming operations need at least four or five years to scale down.
Tax planning as part of your legacy plan helps you bring in the next generation in a gradual way. Let's say a farmer owns 1,000 acres. Each year, he could rent an additional 20% of the acres to the next generation, over a span of five years.
This helps him manage his tax liability. He slowly lowers his expenses – and income – as he farms less land. He keeps both in the proper year. He slowly gets out of the cycle of pre-paying expenses and pushing his income forward.
Doing this also lets the next generation gradually take on more responsibility and acres. They have time to learn about each new piece of land that they're farming. That can help ensure the farm will continue into the future.
Ask your accountant: What would happen to my operation, tax-wise, if I retired tomorrow? Ask them to show you what your last tax bill before retirement would look like. If you're not happy with that number, work with your accountant and estate planner to figure out what makes sense for you and your farm business.
Nobody necessarily enjoys paying taxes. But they have to be paid. You can choose to put it on your timetable so you have some control over how it happens. It's an important part of the legacy of your farm – don't leave it to chance.
We are required by the IRS to include this disclosure: The tax advice contained in this communication was not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
Read more about succession and estate planning:
Estate Planning Brings Tough Questions To Light
Farm Estate Planning: Be Prepared
What's the Succession Plan for Your Farm?
Congressional Action Makes Succession Planning More Meaningful
Key Components of a Succession Plan