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Improved Cattle Profits May Increase Tax Liabilities

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Posted Nov. 1, 2003

The other day, I was visiting with a gentleman who has been a cattle/beef producer for most of his 70-plus years. I asked him if he ever remembered cattle being this high before. He took this opportunity to inform me that cattle prices were not "high" but just what they should be. I can appreciate his view on the level cattle prices are currently. There are probably several other cattle producers who feel the same. Even though cattle prices may not be high in the opinion of some producers, they are at record levels.

Very seldom do all sectors (cow-calf, stockers, feedlots and packers) of the industry enjoy profits at the same time. We need to document these times well so the story can be relayed to our grandchildren with some room to embellish for storytelling's sake. Times are good in the cattle industry. We could discuss the various schools of thought as to why we are experiencing these good times, but my intent for this article is to accept the fact that profits are good and concentrate on how to keep most of them. When times are good and profits abound, we often have to share with Uncle Sam and often his share can be substantial.

There are some basic time-tested practices that are again applicable this year. One of the most basic things to do to keep a higher portion of your income is to keep good records of income and expenses. For example, keep meal receipts when you go to town for parts or to see how your calves are selling. You can deduct one-half of what you spend on meals when you are on a business trip.

Especially at this time of year, if you are a calendar-year taxpayer, keep current on your records so you know what your income and expenses are to date and can estimate what they will be for the rest of the year. By having your tax preparer or an ag economist prepare a tax estimate, you will have information to plan purchases and sales for the rest of the year. Keep in mind that higher cattle prices will likely increase your taxable income this year and therefore increase your tax obligation. It is not a bad thing to pay income tax. It is actually a very good thing. You just need to manage your taxable income so that you only pay your fair amount.

Preparing a tax estimate before the end of the year will help you manage your taxable income. A word of caution do not use the premise of needing to spend some money to reduce a tax bill to justify buying a new pickup or four-wheeler. If you decide you need to spend some money, purchase items that will improve the profitability of the business next year and in the years following. Items that could be considered are improving your livestock water availability with more watering points or maybe supplying existing watering points with higher-quality water. A facility to bulk store fertilizer or feed if the volume purchased would warrant the investment is another consideration. It puts a producer in a different situation when the farm or ranch is making money. It allows you to purchase assets for sometimes 50 cents on the dollar, depending on your tax bracket, because the other 50 cents would have gone to pay taxes. But again, be prudent in your purchases.

A couple of new twists to the depreciation and capital gains laws are available this year. In an effort to spur the economy, Congress liberalized a couple of the depreciation options as well as reduced the capital gain tax rates. The changes in the depreciation alternatives are significant. With the likelihood of higher taxable incomes for cattle producers and maybe wheat farmers with the excellent yields of last June, it is important that each of us have a good understanding of these new alternatives.

For many years, we have had an option (referred to as Sec. 179) to expense, initially up to $10,000, of the purchase price of a capital asset such as a tractor, cow or cattle chute if it was for business use. In more recent years, the $10,000 limit has been increased. For 2002, the limit was $24,000. Normally, the full purchase price of a capital asset has to be capitalized over a three-year, five-year or longer period and the cost written off as depreciation over that time period. For 2003, the expensing limit has been increased to $100,000. This allows considerably more flexibility in managing taxable income with the purchase of capital assets. However, keep in mind that if you expense the full amount of the capital asset, there will be no depreciation deduction in the following years. The IRS is really not increasing the total amount of depreciation, they are just allowing us to recover the cost of a business asset much quicker. The new $100,000 allowance is in effect for 2003, 2004 and 2005. Then the limit returns to $25,000 unless there is further legislation.

Another new twist in the depreciation guidelines is bonus depreciation. You might recall that after Sept. 11, 2001, legislation was passed to allow an additional 30 percent bonus depreciation on new business assets purchased or contracted for after September 10, 2001. The new tax bill increased the bonus depreciation allowance to 50 percent of the initial cost for eligible property acquired after May 5, 2003, and before January 1, 2005. Property acquired in 2003 but before May 6 will likely qualify for the 30 percent bonus depreciation allowance. Keep in mind that only new property is eligible for the bonus depreciation. If you purchase a cow that has already had a calf, she will likely not qualify.

The other item that should be mentioned is the income tax rate on long-term capital gains. The 2003 law reduced the rate from 10 percent to five percent for those in the 10 to 15 percent tax brackets and from 20 percent to 15 percent for taxpayers in the higher income tax brackets. These rates apply to any gain above the original purchase price of a capital asset sold that was owned for more than 12 months. To qualify for this treatment, horses and cattle must be held for at least 24 months. This provision applies to sales after May 5, 2003, in taxable years ending on or after May 6, 2003. These reduced rates will continue through 2008, and then pre-2003 Act rates will return. Another caution here is that any gain due to depreciation has to be recaptured as ordinary income and is subject to regular income tax rates.

For emphasis, I will repeat that paying taxes is not a bad thing. If you do not make any profits, you will likely not owe any tax. If making a profit is a goal for you, then expect to pay a portion of the profits to Uncle Sam. If we make a lot of profit then we may get to pay a lot of tax. Consult with your tax preparer early this year so you will have time to manage your taxable income.

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