Qualifying as a "farmer" for estimate tax purposes.
Most taxpayers are required to make four equal installments of their estimated tax on April 15, June 15, September 15 and january 15. However, special rules apply for farmers and fishermen. Taxpayers who receive at least two-thirds of their gross income from farming or fishing do not have to make quarterly installments. Instead, they are required to make one installment by January 15 of the subsequent year. Additionally, the amount of the installment need only be 66 2/3%--instead of the 90% required of other taxpayers.
The general rule regarding the January 15 payment not being due if any taxpayer files his return and pays the tax by January 31 is also modified for farmers and fishermen. They can disregard the January 15 and January 31 dates if they file their return and pay the tax by March 1.
These special rules apply to taxpayers who receive two-thirds of their gross income from farming or fishing in either the current or prior year. Gross income from farming includes income from the active management or operation of a farm for profit, crops produced on the land or rents based on farm production.
Gross income from farming does not include wages received for farming another person's land or gain from the sale of farmland.
The Moores cannot qualify as farmers based on their prior year activity because gross income from farming ($100,000) was not at least two-thirds of total gross income ($190,000) for the prior year. Additionally, the gain from the sale of farmland during the current year will cause them to fail the two-thirds test because the gain is not considered income from farming. Thus, the Moores would have to make quarterly estimated tax payments under the general rule. Assuming that they cannot use the annualization method or the 100% of prior year tax safe harbor, these installments would be as follows:
Wages $45,000 Farm gross receipts $150,000 Farm expense 100,000) Net income from farming 50,000 Interest and dividends 6,000 Gain from sale of farmland 65,000 Itemized deductions and exemptions (66,100)
Taxable income 99,900
Income tax (rounded) 23,500 Self-employment tax (15.3% of $50,000) 7,650
Total tax 31,150 Required percentage x 90% Total requirement payments rounded) 28,100
Quarterly installment $7,025
(Note that these calculations do not consider the overall limitation of itemized deductions or the personal exemption phase-out.
The Moores can avoid this adverse effect by (1) postponing the sale until January of the subsequent year or (2) closing the sale in the current year but structuring it as an installment sale. In either situation, the Moores would defer the gain until the subsequent year. The deferral would result in less gross income and, thus, increase the percentage of farming income to above 662/3%. This would allow the Moores to qualify as farmers in the current year (year 1). As such, the Moores would be required to make only one installment on January 15 of the following year. In addition, the installment would equal 662/3% of total tax, instead of 90%. This is reflected by the following table:
Wages $45,000 Farm gross receipts $150,000 Farm expense (100,000) Net income from farming 50,000 Interest and dividends 6,000 Itemized deductions and exemptions (66,100)
Taxable income 34,900
Income tax (rounded) 5,300 Self-employment tax (15.3% of $50,000) 7,650 Total tax 12,950 Required percentage x 66 2/3% Installment due January 15 (rounded) 8,650
They would also be able to qualify as farmers in the next year (year 2) because the farm exception applies if the taxpayer meets the gross income test in either the current year or the prior year. Although the Moores' farm income in year 2 would not meet the two-thirds-of-income test, hopefully they would be able to structure year 3 income so that their farm gross income is at least two-thirds of total gross income.
If the Moores recognize the gain from the sale of farmland in the current year, they will not meet the farm exception. Thus, they would have to make quarterly estimated tax payments during the year. However, if they can postpone gain recognition for the sale of farmland, they will qualify as farmers and can use the more beneficial rules for estimated tax payments. Of course, the postponement of gain will also defer tax to the subsequent year. The differences between gain recognition in the current year and the subsequent year is illustrated in the following table:
Not qualifying Qualifying as farmers as farmers Installment payments due: April 15 $7,025 $ -- June 15 7,025 -- September 15 7,025 -- January 15 7,025 8,650 Tax due with the return 3,050 4,300 Total tax $31,150 $12,950
In this situation, the Moores receive a substantial deferral of estimated tax payments and defer a substantial amount of tax from the current year to the subsequent year.
Editor's note: This case study has been adapted from "PPC Tax Planning Guide--Individuals," 5th Edition, by Elizabeth DiTommaso, Helen Gardner and Terry W. Lovelace, published by Practitioners Publishing Company, Fort Worth, Tex., 1993.
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|Author:||Ellentuck, Albert B.|
|Publication:||The Tax Adviser|
|Date:||Mar 1, 1996|
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