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SOMETHING OLD AND
SOMETHING NEW FOR
INCOME TAX
MANAGEMENT
Larry C. Jenkins
Extension Economist
Even though its
“po-wer”
vastly dimished,
the capital gains
provision of the
Internal Revenue
Code is still im-
portant as a tool of HUB* JBI
income tax management. Capital
gain is the term used to describe
gain from disposal of capital
assets; that is, assets the taxpayer
holds for investment or personal
purposes. Special provisions of the
Internal Revnue Code permit gain
from disposal of property used in a
trade or business to be treated as
capital gain. Under pre-1986 law,
that provision provided significant
tax benefits to farmers. Sales of
cull breeding animals, for exam
ple, could qualify for the 60 per
cent capital gain exclusion and
only 40 percent of the gain was
taxed.
The Tax Reform Act of 1986
contains major change in the tax
rules for capital gains. The 60 per
cent capital gain exclusion is no
longer available. The loss of that
exclusion removes part, but not all,
of the tax benefits of capital gain
income.
Fanners will continue to benefit
from capital gain qualifying sales
and should be conscious of the
advantage of increasing this type
income as compared to ordinary
income. For upper income taxpay
ers, capital gain is taxed at a mini
mum 28 percent rate as compared
to top rates of 38.5 percent in 1987
and 3 3 percent in 1988 for ordinary
income. Legislation recently intro
duced in the U.S. Congress prop
oses freezing tax rates at the 1987
level or adding a 5 percent sur
charge on rates provided by the
new tax law. Regardless whether
one of these or other “revenue
enhancing” measures finally
become law, the distinction
between capital gain and ordinary
income will be an important fea
ture of future tax law.
Capital gain income is not
treated as earned income for pur
poses of self-employment tax.
Thus, taxable income that results
from capital gam qualifying sales
is taxed at a rate more than 12 per
cent lower than if the income were
classified as ordinary income. This
provides some incentive for the
producer to arrange production
patterns so as to qualify more sales
as capital gain qualifying sales.
Producers who maintain lives
tock breeding herds can qualify
more sales for capital gain by
increasing culling rates. If breed
ing animals are held long enough
to meet the holding period require
ment (2 years for cattle, 1 year for
hogs), sale of the cull animal is
treated as sale of a capital asset
Income received from these sales
is not subject to self-employment
tax. If the producer is careful in
selecting replacement animals,' he
With These Participatinc
or she may be able to improve
quality and productivity of the
breeding herd at the same time tax
savings occur due to increased
culling rate.
Sales of timber can also produce
capital gain income. The seller’s
decisions and actions determine
how timber sales are treated; they
may produce ordinary income or
they may qualify as capital gain.
A farm operator who cuts and
sells timber from owned land may
treat the income as ordinary
income when the sale is a minor
part of the total farm business. In
the typical case, there is a zero
basis in the timber and all income,
except cutting and selling expense,
is taxed.
Income from the sale of timber
can qualify as sale of a capital asset
in either of two situations;
1. The timber is harvested by the
owner and he or she elects to treat
the cutting of the timber as a sale.
Provided the timber was owned
more than six months, the differ
ence between fair market value of
the timber and it’s basis at the time
of cutting is capital gain (or loss).
The capital gain (or loss) is
GROW WITH CHEMGRO
PROVEN PERFORMANCE
AMMON HOOVER
MANHEIM, PA
PLANTED MAY 8,
HARVESTED OCTOBER 12
HYBRID POP. H 2 Q
YIELD
1^5%
CHEMGRO 7087 22,000 23.1 126.1
CHEMGRO 9087 22,000 27.4 123.1
CHEMGRO 8086 24,500 23.3 120,8
CHEMGRO 7386 22,500 23.5 120.6
CHEMGRO 6386 23,500 21.8 118.6
CHEMGRO 8986 21,000 27.9 117.8
PIONEER 3358 22,000 23,2 112.5
CHEMGRO 6086 21,000 21.2 112.3
PIONEER 3184 22,000 27.8 99.9 ‘
CHEMGRO 3387 22,500 18.1 69.6
COMMENTS: THIS PLOT WAS SEVERELY
STRESSED BY HIGH TEMPERATURES
AND LACK OF MOISTURE DURING THE
GROWING SEASON.
SAVE MONEY! BUY 9 UNITS - GET 1 FREE
reported in the year the timber is
harvested even if the cut timber is
not sold that year. The fair market
value of the timber when cut
becomes the basis for computing
grain or loss at the time the cut tim
ber is finally sold. That final sale
produces ordinary income or loss.
2. Timber disposed of under a
cutting contract qualifies for capi
tal gain if held more than six
months prior to sale. This form of
timber sale requires the owner to
retain an economic interest during
cutting, that is, the owner is paid a
set amount per thousand board feet
as the timber is harvested.
Using the Net Operating
Loss to Reduce Income Tax
Economic conditions some
times adversely affect farming
with the result that individual farm
businesses incur a loss. When this
occurs, the business may have a
net operating loss that can be used
to recover tax paid in prior years or
to reduce future tax payments.
Unfortunately, some farm opera
tors have not been aware of this
provision of tax law. Consequent
ly, they have paid more tax than
required because they did not take
advantage of the net operating loss
provisions of the Internal Revenue
Code.
A net operating loss (NOL) is an
excess of allowable business ({edu
cations for a tax year over gross
income for the .same year. The
NOL may be carried back three
years to recover tax paid in an ear
lier year or, if not totally used in the
carryback period, carried over up
to fifteen years to reduce tax that
would become due in a latter year.
The NOL provides tax relief for
nearly all types of taxpayers except
partnerships. Individuals, corpora
tions, estates, and trusts can all use
the NOL in alleviating the tax
obliation.
Chemgro
'l*p
Seeds
Partnerships are not allowed a
NOL carryback or carryover.
However, each member of the
partnership may enter his or her
share of partnership loss on the
individual tax return. If the loss
exceeds income for ayear, the loss
can be carried back three years and
forward fifteen years.
“S” corporations, like partner
ships, also are not permitted a
NOL carryback or carryover. If a
loss occurs, it may be passed to the
individual “S” corporation share
holders on a pro-rata basis just as
with the partnership. There are
special rules for determining the
number of years to which a loss
may be carried back or forward.
NOL carryback and
carryover:
The NOL of an individual is first
carried back to the third year pre
ceding the year of loss and applied
against income in that year. Tax is
then recomputed for the earlier
year and a claim for credit or
refund is made for the amount of
tax reduction. If the NOL is not
fully used in the third year preced
ing the year of loss, the amount not
used is carried to the second year
and then to the first year preceding
the year of loss. The NOL can also
be used in the years following the
year of loss and can offset income
for up to fifteen years after the year
of loss.
Two steps are essential in carry
back of an NOL. The first of these
is to convert the accounting loss to
a net operating loss. The account
ing loss is the amount of loss
reflected in the record book at the
end of the business year. The
accounting loss is converted to a
net operating loss by using a work
sheet that is attached to the tax
form used in filing the NOL. The
SEND FOR 1987 SHELLING TEST PLOT RESULTS
NAM
ADDRESS,
CHEMGRO Box 218 East Petersburg, PA 17520
(717) 569-3296 or (800) 346-GROW
(4769)
JOHN GOOD
NARVON, PA
PLANTED MAY 8,
HARVESTED OCTOBER 13
HYBRID POP. HgO
YIELD
15.5%
CHEMGRO 8086 23.000 22.4 169.7
CHEMGRO 8086 *22.500 22.6 161.5
CHEMGRO 6386 23,000 19.5 158.2
CHEMGRO 8086 *23.000 22.9 154.8
CHEMGRO 7386 25.000 22.9 154.7
CHEMGRO 6086 22.500 18.9 151.4
CHEMGRO 7087 28,500 22.1 145.7
FUNKS G 4543 22.000 23.2 142.7
CHEMGRO 8986 23.000 27.0 142.3
DEKALB 689 24.500 25.6 142.0
CHEMGRO 9087 22.500 27.-1 134.8
CHEMGRO 3387 23,000 17.5 117,6
COMMENTS: * THESE YIELD RESULTS OF
CHEMGRO 8086 WERE FROM CHECK
LOCATIONS AT EACH SIDE OF PLOT
worksheet is indentifietTas 'ftjmn ’
1045, schedule A.
The NOL is usually slightly
smaller than the accounting loss
reported by an individual. The rea
son for the difference is that certain
deductions can be taken in deter
mining the accounting loss that are
not allowed when computing the
NOL. These nondeductible items
for purposes of the NOL include
the personal exemption, NOL
from other years, and some types
of capital losses.
Step two in filing a NOL is to
complete a form 1045, entitled
‘‘Application for Tentative
Refund.” This form is used to
report income and tax as originally
filed and the corrected information
due to carryback of the NOL. The
amount of the tax refund is also
computed on the form 1045. The
completed form 1045 must be filed
by December 31 of the year fol
lowing the year when NOL
occured. For example, an NOL in
1987 must be filed by December
31. 1988.
The NOL is a valuable tax man
agement tool because it provides
the taxpayer with a method of con
necting a given tax year to earlier
years and subsquent years. Losses
from a given year can be applied
against earlier tax payments or
used to reduce taxable income in
future years. In either case, total
tax paid over a period of years can
be reduced by application of the
net operating loss. (Admittedly, it
is preferable to never have a NOL
but they sometimes occur, even
with the best of management). The
net operating loss provisions can
be used to partly compensate for
the loss of income averaging
which was repealed December 31,
1986 as part of the Tax Reform Act
of 1986.