Farmers are in the business to make money. Whether they raise livestock or grow vegetables, they are working to earn a living for themselves and their families. Like any businesspeople, farmers use permissible deductions to reduce their taxable income and their overall tax liability.
Farm Business Expenses
The Internal Revenue Service allows a deduction for any expense necessary for the business to operate. This may include a proportional amount of the living expenses for the farmers themselves. Most farms include the farmer's personal residence, which is indistinguishable from the farm itself. A comparative amount of the utilities, depreciation and loan interest is included in the expenses for operation of the farm, while the remaining is not deductible as it relates to personal expenses.
Equipment Purchases
Farmers need equipment and tools to remain in business. They can deduct the cost of these purchases and the total ancillary costs associated with the purchase to get the item ready for its intended use. Farmers usually deduct, or depreciate the equipment over its useful life rather than in the year of purchase.
Section 179 Expense
The Section 179 expense is an alternative to the depreciation method previously mentioned. The Internal Revenue Service understands the necessity of equipment to stimulate growth in businesses. Without new and efficient equipment, many businesses cannot continue to move forward. To help facilitate expansion, they implemented the Section 179 expense allowing companies the ability to deduct the full cost of equipment in the year of purchase. For the 2010 tax year, the Internal Revenue Service limits this deduction to a cap of $500,000; however, this deduction is subject to change each tax year.
Income Averaging
Farmers make money sporadically throughout the year. Many times the money they make is from the fruits of their labor from prior years. In order to alleviate a tax bill that is just as sporadic as their income, they can deduct this income from the current year and allocate it to the three prior years. Moving income to a prior year that contained a loss allows the farmer to reduce taxes in the current year, while not affecting their tax liability in a prior year.
Non-Deductible Expenses
Most farmers take out loans to operate their farms. Their income is intermittent and daily operations require a daily infusion of cash. Bank loans help to fill the cash-flow gap created and keep the farm running smoothly. The deduction of payments made to service the loan is limited to the interest only. Principle payments are not deductible as they are a return of capital to the lending institution and not an expense to the farm itself.
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