FARM INCOME TAX MANAGEMENT

The objectives of this exercise are:

1) to illustrate how federal income taxes and self-employment tax are
computed.
2) to show how selling decisions at the end of the year can affect taxes
and interest costs.

Complete the lines below for the indicated Internal Revenue Service (IRS)
forms. Assume the return is for a married couple filing jointly, with two
children.

Schedule F--Profit or Loss from Farming

Line 1. Record sales of cattle. $ 96,731

Line 2. Record the original purchase cost of the cattle. $ 41,619

Line 3. Subtract to find the taxable gain on cattle. $ 55,112

Line 4. Record sales of corn, soybeans and hogs. Do not include
$141,622
sales of culled breeding stock—they are taxed as capital gains.
Do not include loans received—they are not considered income.
Line 8. Record any crop insurance payments received. $14,300
Line 11. Gross income (sum lines 3 to 10) $211,034
Line 35 Record all operating expenses, except purchases of feeder
livestock and depreciable assets. $142,698

Line 36. Find Net Farm Profit (line 11 – line 35). $ 68,336

Schedule SE--Self-employment Tax

Medicare tax: 2.9 % of Net Farm Profit $ 1,982

Social Security tax: 12.4 % of Net Farm Profit, paid on a $ 8,474

maximum of $106,800
Total self-employment tax $ 10,456

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Form 1040. U.S. Individual Income Tax

Complete all the lines that are indicated for Form 1040.

Line 13. Sales of culled livestock qualify as capital gains income.

(100% if raised on the farm) $ 13,610

Line 18. Farm income (from line 36 of Schedule F). $ 68,336

Line 27. One-half of self employment tax (from Schedule SE). $

5,228

Line 37. Adjusted gross income (line 13 + line 18 – line 27). $

76,718

Line 40. You get to subtract the standard deduction of $11,400 for a
married couple filing jointly. $ 11,400

Line 42. You get an exemption of $3,650 each for four persons. $ 14,600

Line 43. Federal taxable income (line 37 – line 40 – line 42) $

50,718

Ordinary income to be taxed (line 43 – line 13) $ 37,108

Line 44. Calculate the federal income tax on ordinary income.

a. 10% of your first $16,750 $ 1,675
b. 15% of everything from $16,750 up to $68,000 $ 3,054
c. 25% of everything from $68,000 up to $137,300 $ 0
d. Total federal income tax on ordinary income $ 4,729

e. Federal income tax on capital gains income (line 13 x 15%) $

2,042

f. Total tax on ordinary income and capital gains $ 6,771

Line 53. Tax credit for two children ($1,000 per child)
$ 2,000

Line 58. Enter self-employment tax from page 1. $ 10,456

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Line 63. What is your total federal and self-employment tax due? $
15,227
(line 44 total – line 53 + line 58)

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Marginal Tax Rate

The marginal tax rate (MTR) is the total amount of additional tax due on one
additional dollar of taxable income. What was the MTR in this example?

Medicare 2.9 %
Social Security 12.4 % (if income is under the maximum)
Federal 15.0 % (tax rate on the last dollar of ordinary income)
Total 30.3 %

Note: Many states also impose a tax on income, which would increase the
marginal tax rate.

Tax Savings

Postponing reporting taxable income results in postponement of taxes, and

having the use of the money that would have been paid in taxes for an
extra year.

1. How much added tax would you have to pay if you had sold all of your
corn that you had at the end of the year for $20,000 additional revenue?

$20,000 x 30.3 % $ 6,060

2. How much additional interest cost would be incurred by having less cash
available due to paying taxes a year earlier? Multiply line 1 by an
assumed interest rate of 8 %.

$6,060 x 8 % $ 485

3. How much interest cost would be saved by having cash available from
selling corn sooner? Assume the sale value would not change from your
calculation in line 1, and that income would be received 4 months
sooner. Multiply line 1 by 8 %, for 4 months.

$20,000 x 8% x 4/12 year $533

4. Would the interest savings have exceeded the extra interest cost from
paying taxes a year sooner?

yes

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