If you reimbursed an employee for individual health care costs, received a crop insurance indemnity payment, traded commodity options this year or had a lot of repair bills, your 2014 taxes just got more complicated.
That doesn’t even count the anxiety Congress caused by not extending the $500,000 section 179 expense deduction limit until the 11th hour. The House of Representatives on Wednesday passed a bill to extend the higher expense limit for 2014. The bill now goes to the Senate and if it passes (which tax experts expect), the president will likely sign it next week.
Meanwhile, if you don’t offer employees group health care coverage and instead paid for your employees’ individual health insurance premiums or reimbursed their medical costs, stop doing that, tax experts advised. That generosity could backfire on small employers.
A Department of Labor and Treasury memo issued Sept. 13 surprised many CPAs by imposing onerous fines on the practice. Most tax professionals had wrongly assumed the income would be taxable to employees and employers, but not subject to $100/day fines per employee under the Affordable Care Act. The government decided differently. (For details check here).
Unless your health payment re-imbursement falls under three exempt categories: (1) only a one-employee health plan; (2) an employer-provided group insurance plan; or (3) you only reimbursed costs for “ancillary benefits” such as dental, vision, or long-term care premiums, IRS says you may be subject to a penalty of as much as $100/day per employee under the Affordable Care Act.
REMEDY FOR IMPROPER HEALTH REIMBURSEMENT
Before you fill out your employees’ 2014 W-2s, be sure to consult your tax adviser, said Paul Neiffer, a CPA and tax principal with CliftonLarsonAllen. If you take actions to amend the practice within 30 days of becoming aware of the Department of Labor guidance, you may be exempted from the penalties.
The money you paid still should be considered taxable earned income. Your employees will have to cover their own insurance premium and other health costs.
The increase in taxes is not insignificant, Neiffer added. Assume a farmer pays $10,000 for his employee’s health insurance. For 2013, the farmer could deduct these premiums and the employee paid no tax on the benefit. Beginning this year (assuming it is not a qualified group plan), by adding that amount to the employee’s paycheck, the employer and employee will each incur $765 of payroll taxes and the employee will owe $1,500 or more of income tax.
Small employers are really left with only two choices to assist employees with their health care costs, CPAs tell DTN. Either they provide group health insurance or they increase taxable compensation without any connection to the employee’s out-of-pocket health care costs.
“That is certainly a change for a lot of farm employers,” said Brad Palen, CPA with Kennedy & Coe in Salina, Kan. “Our farm clients have had to go to their employees and say, ‘We used to be able to pay your health insurance premium, as a non-taxable benefit. We can’t do that anymore, so we’ll pay you more in taxable income and you’ll have to pay your own insurance premium.’ Qualified group plans aren’t affected. But fewer farm employers have those because they are more expensive,” Palen explained.
DIG INTO CROP INSURANCE
For most farmers, there are two components to their crop insurance indemnity payment, one related to yield loss and the other related to price decline. The amount paid because prices declined between sign-up and harvest is not deferrable to the following year, even if that’s when you generally would have sold your crop. For that portion, when you receive your check is the year you must report the income due to a price decline.
“We have some farmers who just finished harvest in November and they are not going to get their paper work done in time to get a check before January 1,” reported Lynn Lambert, CPA with Lambert, Lanoue & Smoker in LaPorte, Ind. “So, they will report that income for 2015. But for others, it is 2014 income.”
For the yield loss portion of your crop insurance payment, you can defer that portion of your payment into 2015, if you historically sell more than 50% of your crop in the next calendar year following harvest. That is, for checks received in 2014. The deferment is only into the year you would have generally sold your crop.
“You can’t defer a 2014 crop payment received in 2015 into the year 2016,” explained Lambert. You’ll have to look at your insurance records or call your insurance agent to get the proportionate amounts to see if you can defer part of your indemnity payment, Lambert advised.
Also, “it’s an all or nothing election. You can’t defer income on one crop and not on another,” added Palen.
Farmers with fall-seeded crops sometimes get tripped up when the next year’s premium is subtracted from the indemnity payment, noted Neiffer. “For example, you have a $300,000 yield claim and the premium for next year’s crop insurance is $50,000. You get a check for $250,000, but the 1099 from the crop insurance company says you got $300,000. I’ve seen the premium deduction get missed because the farmer didn’t write the premium check, so he forgets to deduct that.”
In all of these recommendations, the tax accountants assume you are a cash-basis taxpayer.
INCOME MAY DIFFER FROM YOUR BROKER’s 1099
A DTN reader sent this question: “I have significant profit (over $100,000) in my grain hedge account. Approximately one-half is from closed futures trades; the remainder is from sold out-of-the-money calls and puts for both the 2014 and 2015 crops. How do I translate my monthly brokerage statements to determine my estimated 1099 income for 2014?”
Answer: What is reported on your brokerage account 1099 is not necessarily the income you will report, advised our tax experts.
First, to keep your trading gains and losses in the proper buckets, you have to determine if each trade was hedging or speculating. (IRS publication 225 explains the difference with examples).
Next, when did you sell the grain that was protected by the hedge? “You can lift the hedge in September, but if you don’t sell the cash commodity until 2015, you can recognize the hedging gain in the year you make the cash sale,” said Neiffer. “Farmers with over $5 million in sales must recognize the hedging gain or loss when they make their cash sale. For farmers under $5 million, they can choose to report their hedging gain or loss in the year the trade is closed or when they make the cash sale. The important thing is to be consistent. You can’t tie your futures gain or loss with the timing of the cash sale in one year and then do something different the next year,” Neiffer advised.
Reporting your options gain or loss is a little trickier. Your brokerage firm has to report “marked to market” on 12-31-14 for your options trading, but you don’t have to recognize that if your option position is still outstanding and it’s a hedge, not a speculative position.
“The farmer does not have to report “marked to market” gains or losses on open hedged option positions,” said Palen. “The broker will likely report it that way on the 1099, but we haven’t had a lot of issues with IRS over reporting a different hedging income figure than the one stated on the 1099. IRS recognizes that 1099s are often different for farmers.”
“What may trip some farmers,” said Palen “is the common practice of selling your grain and then buying it back on the Board. Even though a farmer may think that is a price hedge, IRS says that is speculative and the tax treatment is different.”
CORRECTLY CATEGORIZE REPAIR BILLS
IRS has added additional filing requirements for repair expense versus capital expense. Essentially, for any repair over $500, you now have to justify if it is a repair (part of routine maintenance) or if it is a “betterment, restoration or an adaption” to that property.
“I just spent a half hour with a client who has $1.5 million in sales, simply going through every repair invoice over $500,” explained Lambert. “For example, he had a $1,600 bill for electrical and computer repair on his tractor. Our reasoning: Farm equipment is hard on computers. Dirt gets into it. We will likely have to replace it again. It was a ‘repair’. He spent $650 on a new countertop in his office and enlarged his desk area. We are required to capitalize that. Tractor tires are a repair.
“We wrote notes to explain why we determined each repair deduction because in three years if we get audited, IRS will want to know our justification. We want to avoid the 20% penalty for understating income,” Lambert added.
On repair bills, Palen tells his clients to ask themselves, do you expect to replace this item more than once during its useful life? Then it is a repair.
Traditional tax strategies of deferred payment contracts, pre-paid expenses and income averaging continue to be valuable year-end tax planning tools. But this year, you may need also some extra documentation to fully utilize tax-saving and penalty-avoiding strategies.