As enrolled agents and CPAs well know, as does any registered tax agent schooled by tax CPE, tax continuing education courses for tax professionals, all taxpayers are faced with the choice of taking the standard deduction or itemizing their deductions when filing the federal income tax return.
IRS Publication 225 Any tax professionals looking to develop a further understanding of the tax incentives for farming should first download and read IRS Publication 225 – Farmer’s Tax Guide. It was co-authored by the IRS and farm extension specialists, and explains in plain language the complicated tax rules that apply to most farmers. Business vs. Hobby Farming There are significant financial differences between the classification of a farm as a business versus its classification as a hobby. When the farm does not constitute the taxpayer’s sole or primary business, the related deductions are significantly limited. When a farm is the primary business, dozens of tax incentives are instantly available. Again, Publication 225 explains the criteria for classifying a farm as a business, most notably, (a) demonstrating intent to make a profit and (b) succeeding in making the farm a profitable venture in three years of a five-year period.
Many businesses incorporate so they can raise capital to expand the business or easily transfer ownership units. For single-owner businesses, the reasons generally involve protecting personal assets and saving taxes, but these advantages come with a price.
Farm Depreciations According to the IRS, taxpayers are required to depreciate capital farm asset purchases over the period of their usefulness, as opposed to a one-time deduction of the full expense. Capital assets can include such items as farm buildings and equipment. Home and Business It is more often the case than note that farmers live where they work. This can present certain difficulties come tax time, particularly around separating business and home costs because many bills (such as electricity or gas) are often shared. However, the IRS does allow farmers to estimate the percentage of these expenses that related to the farming business.
Limited itemized deductions A taxpayer’s itemized deductions are no longer limited because of adjusted gross income. Married Filing Separately If a married couple files separate returns and one spouse itemizes deductions, the other spouse is prohibited from claiming the SD and is required to itemize all allowable deductions.
Not all taxpayers are eligible for the standard deduction Individuals deemed ineligible by the IRS include: nonresident aliens dual-status aliens individuals filing returns for periods of less than 12 months due to a change in accounting periods
The S election allows you to report the corporation’s profit on your personal tax return. Depending on your personal tax bracket and the company’s profits (or losses), good planning could make a difference in your total tax bill. As a shareholder in an S Corporation, you draw a reasonable salary for which you pay Social Security and Medicare taxes. You’re entitled to also take a stockholder distribution, which is not subject to the payroll taxes. If done correctly, you can save up to 15.3% (combined rate for Social Security and Medicare taxes) on the amount of the distribution. Be aware that there are limitations on the amount of distribution allowed before triggering other tax implications. This is why you need the help of a tax professional.
A primary reason to incorporate is to remove the risk of loss due to financial obligations or lawsuit from the personal assets of the shareholders. To accomplish that goal, though, you must walk, talk, look, and smell like a corporation. That means you must file all corporate paperwork in a timely fashion, conduct formal meetings of your stockholders and board of directors, and keep minutes of actions taken. Follow these guidelines, and then if a problem arises, you’ve taken the steps to prove a true corporate existence. It’s not difficult to form a corporation yourself these days. Go online to your state’s website to look for the name you want, check to see if it’s available, complete the application, pay the fee, and you’ll have a corporation within minutes. But what you do next determines the benefits to you. Talk to your CPA and get all the information you need before you set up the corporation. Planning the tax benefits is unique to each individual, so don’t make decisions based on what you learn at a cocktail party.
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