Time for Annual Tax Planning

At the Ranching for Profit School, we explore “3 Issues of Money” that we label as Economics, Finance, and Income Tax. That is the correct order to consider when making financial decisions. Does it make money? How does the cash flow? What is the tax bill at the end? It is easy to use some financial terms interchangeably, but here is how we define them.

• Economics is producing value and calculating profit by accounting for all cash AND non-cash transactions. The main question is “should I?”
• Finance is monitoring cash flow to be sure all bills are paid on time in full, and deciding the best use of excess cash flow. The main question is “can I?”
• Income taxes are good problems (or a double edged sword) as profitable businesses will have tax liabilities. It is up to us as business owners to determine the best way to manage them, not minimize! Trying to minimize taxes every single year puts us in a scarcity mindset. Managing profitability and cash flow to increase after-tax wealth puts us in an abundance mindset.

Year end tax planning with your tax preparer is an incredibly useful tool for you and your business. First review your records year-to-date to make sure everything is classified correctly and all questions are answered, this will allow you to start off with accurate numbers. Your tax preparer will know important carryforward items like depreciation, resale cattle cost, net operating losses, etc. Next make a list of cash incomes and expenses that will for sure happen before year end. Here is where the conversation starts. 

Remember we want to focus on what is good for business as a whole, so we account for economics, finance, and income taxes.

• What does your tax bill look like with that scenario?
• What is your composition of income this year? Farm and ranch income, asset sales, wages, etc. Do you understand the tax liabilities of the different incomes?
• Look at the last three years of incomes and expenses. It’s good to look at trends or similarities between the years and will help identify those year end bills or payments that might have been overlooked.

After we know what is in the books and what we know will happen, then it is time to run some scenarios on what could happen.

• Prepays and delays. Almost everyone files as cash basis taxpayers, so the timing of incomes and expenses can be critical. Prepaying expenses when they are cheaper and tax deductible is good for business, if you have the cash flow available. If you defer income to the next year, do it properly. If you are a farmer, grain elevators can issue a deferred contract where they obtain title to the grain this year, but can pay you next year. Livestock sales are a little trickier to defer, so talk to your tax preparer about the best way if that is needed. A drawer full of checks that magically get deposited into your bank account on the first Monday of the New Year is not a proper deferral.
• Capital purchases and accelerated depreciation. Accelerated depreciation works like a charm when used properly. When misused, it can cause major problems in the future. If you buy capital purchases with profit and cash, it is not a problem to write it off that year. When you buy capital purchases with borrowed money and use accelerated depreciation, the loan payments in the future years can be a major cash crunch.
• Other incomes on your individual tax return. Most farms and ranches have other incomes like off-farm wages, investments, rents and royalties, and maybe other businesses. So make sure to focus on the whole picture of your net worth.
• Be aware of what next year’s tax liability might look like. The decisions you make this year will affect next year. It’s okay to have a deferred tax, but know how big it is, and be prepared to handle it in the future. Cash flow and the stage your business is in will influence your decisions on when to pay.

The last step would be to make a good plan with your tax preparer, and possibly your lender. Everyone on your team should be informed, but it is your responsibility to make the final decision. Starting these meetings before the end of the year with a month or more to think and act on everything will give you time to decide on something, stick with it, and don’t doubt yourself. Even if there is a bigger tax bill than you might like, just knowing will give you some peace of mind throughout the winter months. I know none of you want a big surprise at filing time. So I recommend you set aside some time this weekend to go through the tasks I have listed above and see what you need to work on before the end of this tax year. I know taxes can be boring but tax planning is essential for effective leadership in running a profitable business.  As always, find a good tax preparer who understands your business and treat them well!