© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 9-1 Chapter 9 Taxes STARTEXIT.
© Mcgraw-Hill Companies, 2008 Farm Management Chapter 16 Managing Income Taxes.
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Transcript of © Mcgraw-Hill Companies, 2008 Farm Management Chapter 16 Managing Income Taxes.
© Mcgraw-Hill Companies, 2008
Farm ManagementChapter 16
Managing Income Taxes
© Mcgraw-Hill Companies, 2008
Chapter Outline
• Objectives of Tax Management
• Tax Accounting Methods
• The Tax System and Tax Rates
• Some Tax Management Strategies
• Depreciation
• Capital Gains
© Mcgraw-Hill Companies, 2008
Chapter Objectives1. Show the importance of income tax management
2. Identify the objectives of income tax management
3. Discuss the difference between cash and accrual methods of computing taxable income
4. Explain how marginal tax rates and social security taxes are applied to taxable income
5. Review some tax management strategies
6. Show how depreciation is computed for tax purposes
7. Know the difference between ordinary income and capital gains income
© Mcgraw-Hill Companies, 2008
Objectives of Tax Management
The goal of the manager should be tomaximize long-run, after-tax profit. Effective tax management requirescontinuous evaluation of how decisionswill affect income taxes. The managerwill want to avoid payment of any taxesnot legally due and to postpone paymentof taxes whenever possible.
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Tax Accounting Methods
• The cash method
• The accrual method
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The Cash Method
• Income is taxable when it is received as cash or “constructively received”
• Income is constructively received when it is made available for use before the end of a tax period
• Expenses are deducted when they are paid
• Inventories do not figure into taxable income
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Advantages of Cash Method
1. Simplicity
2. Flexibility
3. Sale of raised breeding livestock likely to qualify for capital gains treatment
4. Delaying tax on growing inventory
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Disadvantages of Cash Method
1. Poor measure of income
2. Potential for income variation
3. More tax paid in years of declining inventory
© Mcgraw-Hill Companies, 2008
The Accrual Method
• Income is taxable when earned or produced
• Expenses deductible when incurred
• Inventories figure into taxable income
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Advantages of Accrual Method
1. Better measure of income
2. Reduces income fluctuations
3. Less taxes paid during times of declining inventories
© Mcgraw-Hill Companies, 2008
Disadvantages of Accrual Method
1. Increased record requirements
2. More taxes paid when inventory is increasing
3. Loss of capital gains treatment on sale of raised breeding livestock
4. Less flexibility
© Mcgraw-Hill Companies, 2008
Tax Record Requirements
• Complete and accurate records essential for good tax management and proper reporting of taxable income
• Complete records include a list of receipts and expenses for the year, a depreciation schedule, and records on real estate and other capital items
• Computerized systems can be helpful
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The Tax System and Tax Rates
• Federal taxes based on marginal rates• Rates and income brackets for rates
change and need to be checked each year• Taxable income includes farm income as
well as income from all other sources minus personal exemptions and deductions.
• Self-employment tax includes Social Security and Medicare taxes.
© Mcgraw-Hill Companies, 2008
Federal Income Tax, 2006
Taxable IncomeMarried Filing Jointly Single 2006$0-$15,100 $0-$7,500 10%$15,100-$61,300 $7,500-$30,650 15%$61,300-$123,700 $30,650-$74,200 25%$123,700-$188,450 $74,200-$154,800 28%$188,450-$336,550 $154,800-$336,550 33%over $336,550 over $336,550 38%
Marginal Tax Rates
© Mcgraw-Hill Companies, 2008
Example: Calculating Income Tax Due
Income = $80,000Married filing jointly
10% on the first $15,100 $1,51015%on the next $46,200 6,930 ($61,300-$15,100)27% on the next $18,700 15,049 ($80,000-$61,300)Total tax due $13,489
© Mcgraw-Hill Companies, 2008
Self-Employment Tax
Year 2006
Income subject to self-employment tax Rate
$0-$94,200 15.3%Over $94,200 2.9%
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Some Tax Management Strategies
• Form of business organization
• Income leveling
• Income averaging
• Deferring or postponing taxes
• Net operating loss (NOL)
• Tax-free exchanges
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Depreciation
Depreciation plays an important role in tax management. It is a non-cash, tax-deductible expense. Some flexibility is permitted in calculating tax depreciation.
© Mcgraw-Hill Companies, 2008
Tax Basis
The tax basis of an asset is its value fortax purposes at a point in time. At the timeof purchase, it is called a beginning taxbasis. As it changes, it is called anadjusted tax basis.
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Beginning Tax Basis
Any asset, new or used, purchased directlyhas a beginning tax basis equal to thepurchase price. When an asset purchaseincludes a trade-in, the traded-in assetcontinues to be depreciated as if it werestill owned. Beginning basis on the newasset is equal to the cash paid to completethe trade (called the “cash boot”).
© Mcgraw-Hill Companies, 2008
MACRS Depreciation
• 3-year: breeding hogs• 5-year: cars, pickups, breeding cattle and
sheep, dairy cattle, computers, trucks• 7-year: most machinery and equipment,
fences, grain bins, silos, furniture• 10-year: single-purpose agricultural and
horticultural structures, fruit or nut trees• 15-year: paved lots, wells, drainage tile• 20-year: general purpose buildings
© Mcgraw-Hill Companies, 2008
Table 16-1Regular MACRS Recovery Rates
Be sure to always check current tax code
Recov ery 3-year 5-year 7-year
Year class class class
1 25.00 15.00 10.71
2 37.50 25.50 19.13
3 25.00 17.85 15.03
4 12.50 16.66 12.25
5 16.66 12.25
6 8.33 12.25
7 12.25
8 6.13
Recov ery Percentages
© Mcgraw-Hill Companies, 2008
Alternative Depreciation Methods
• Regular MACRS class life or recovery period, with straight-line depreciation
• Alternative MACRS recovery periods (usually longer than regular MACRS) and 150 percent declining balance
• Alternative MACRS recovery periods with straight-line depreciation
© Mcgraw-Hill Companies, 2008
Expensing
Section 179 of the tax regulationsprovides for “expensing,” an optionaldeduction which can be taken onlyin the year an asset is purchased. Most3-, 5-, 7-, and 10-year class propertyis eligible. The maximum allowed hasincreased several times in the past andwas $108,000 in 2006.
© Mcgraw-Hill Companies, 2008
Depreciation Recapture
Whenever an asset is sold for morethan its adjusted basis, the differenceis called depreciation recapture. Depreciation recapture is taxed asordinary income for the year of sale.
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Capital Gains
Capital gains can result from the sale orexchange of certain types of qualifiedassets. It is the gain or profit made by selling an asset for more than its originalpurchase price. To qualify, the assethas to have been held for a specifiedminimum amount of time.
© Mcgraw-Hill Companies, 2008
Taxation of Long-Term Capital Gains
1. Capital gains income is not subject to the self-employment tax.
2. Capital gains income is generally taxed at a lower rate than ordinary income.
© Mcgraw-Hill Companies, 2008
Capital Gains and Livestock
• Cash-basis farmers have a basis of zero on raised breeding or working livestock; hence the entire sales value can often be treated as capital gains.
• Purchased livestock may also be eligible, but only if sales price is above original purchase price.
© Mcgraw-Hill Companies, 2008
Summary
A business manager should seek tomaximize long-run, after-tax income. A number of tax management strategiesare available.
