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What's New: Farm Income Taxes

Farm Management Update, December 1996 - January 1997

By Frank Smith of the Department of Agricultural and Applied Economics, Virginia Tech

In a year which had supposedly very little tax legislation, there were significant tax provisions in the Small Business Jobs Protection Act (August 20, 1996), the Health Insurance Portability and Accountability Act (August 21, 1996), the Personal Responsibility and Work Opportunity Reconciliation Act (August 22, 1996), and the Taxpayer Bill of Rights 2 (July 30, 1996). The following tax provisions are effective for tax years beginning after December 31, 1996.

Simple Retirement Plan:
Farmers and their employees who do not maintain another employer-sponsored retirement plan can elect to establish a simplified retirement plan designed for small businesses with 100 or fewer employees with at least $5,000 in compensation for the preceding year. Employees make elective contributions expressed as a percentage of their compensation and cannot exceed $6,000 per year. Employers match employees' contributions up to 3 percent. Vesting is immediate and there are penalties for early withdrawal. Contributions are deductible by the employer and excludable from the employee's income, thus they are includable in income when withdrawn.

Medical Savings Accounts:
On a trial basis for the next three years, farmers with no more than 50 employees and their employees who are covered by an employer-sponsored high-deductible health plan and not covered by any other health plan can make contributions to a Medical Savings Account (MSA). The maximum annual contribution that can be made to an MSA for a year is 65 percent of the deductible under the high-deductible plan in the case of individual coverage and 75 percent in the case of family coverage. (A high-deductible plan is a health plan with annual deductible of a least $1,500 and no more than $2,250 in the case of individual coverage, and at least $3,000 and no more than $4,500 in the case of family coverage.) Individual contributions are deductible and employer contributions are excludable (within limits) including the self-employed individual (farmer), the deduction cannot exceed their earned income. Distributions from a MSA for the medical expenses of the individual and his or her spouse or dependents generally are excludable from income.

Spousal IRA Deduction:
Deductible IRA contributions of up to $2,000 are permitted to be made for each spouse (including, for example, a homemaker who does not work outside the home) if the combined compensation of both spouses is at least equal to the contributed amount.

Section 179 "Expensing":
The amount of qualified property to be "expensed" is increased from $17,500 to $25,000 over 7 years beginning in 1997 which goes to $18,000. Horses become eligible for "expensing".

Self-Employed Health Insurance Deduction:
The deduction for the cost of health insurance for farmers and their families increases to 80 percent over a 10 year period beginning in 1997 when it goes to 40 percent.

FUTA Exemption for Alien Agricultural Workers:
(This provision is effective for labor performed on or after January 1, 1995.) It permanently extends the Federal Unemployment Tax exemption for alien agricultural workers. (Consider filing an amended return for FUTA paid for 1995.)

Accelerated Death Benefits:
An exclusion from gross income as an amount paid by reason of terminal illness from life insurance contracts is provided. "Terminal illness" is defined as an illness or physical condition that a physician has certified can reasonably be expected to result in detah within 24 months of the date of certification.

Long-Term Health Care:
(A complex provision and only basic rules are included.) Amounts received for personal injuries and sickness under a long-term care insurance contract are excludable from gross income subject to $175 per day or $63,875 annually, on per diem contracts only. Long-term care insurance premiums that do not exceed specified dollar limits are treated as medical expenses for purposes of the itemized deduction for medical expenses. The present law of 30 percent deduction for a farmer's medical expenses is increased up to 50 percent.

Sub-S Corporations:
Farms which are Sub-S Corporations can now have a maximum of 75 stockholders which is up from the 35 in the old law.

State Income Taxes

Advanced Technology Pesticide and Fertilizer Applications Equipment:
Effective Date: July 1, 1996. Adds "starter fertilizer banding attachments for planters" to that equipment eligible for the credit. The due date of the tax return is now the required date for an approved Nutrient Management Plan.

Agricultural Best Management Practices Tax Credit:
Effective Date: January 1, 1998. Gives a tax credit equal to 25 percent of the first $70,000 expended for practices such as animal waste management, soil erosion control, filtration, nutrient management, and pest management. The credit cannot exceed $17,500 or the tax imposed for the year the project was completed. The credit is non-refundable, however, the portion of the credit that exceeds the tax liability may be carried forward to the next five taxable years. The soil conservation plan must include "agricultural best management practices" that are approved by the Virginia soil and Water Conservation Board. Such practices include, but are not limited to livestock and poultry waste management, soil erosion control, nutrient and sediment filtration and detention, nutrient management, and pest management and pesticide handling. The credit is based on expenditures made from the taxpayer's own funds.

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