Written by David M. Hanson, CPA
Estimated Taxes – The Basics
Estimated taxes are, like so many items in the tax law, relatively simple in concept but get bogged down in the details very easily. This article will focus on the rules as they apply to a sole proprietor self-employed farmer. The estimated tax rules, as they relate to corporations, are a different matter and will not be discussed herein (sorry to disappoint you….).
Estimated taxes, whether for a farmer or any other individual, are a way to pay to the government a taxpayer’s income tax liability for any given year. It’s probably not a surprise that the government wants it’s income tax money from the citizenry as quickly as possible, i.e., they don’t want to wait until the end of the year.
In general, estimated taxes apply to and are required for any individual who doesn’t have sufficient income taxes withheld from their various sources of income to cover their ultimate tax liability. This situation differs from an individual whose overall primary sources of income come from wages (in other words, they are an employee). In this situation, taxes (federal, state, and local if any) are directly withheld from the employee’s paycheck. In theory, the taxes withheld from the employee’s wages will equal the employee’s ultimate tax liability and consequently, no further taxes are due the government.
Estimated Taxes for a Farmer
Unlike the rules that apply to a typical wage earner or, for example, a taxpayer whose sole source of income comes from interest and dividends, special rules apply for farmers if the farmer chooses to take advantage of them. Most farmers, but not all, take advantage of these special rules when they can.
The first test/hurdle that must be overcome in order to apply the special farmer rules is that the farmer must be deemed to be a farmer in the eyes of the tax law. In general this test is relatively simply. Specifically, in either the current year or the prior year, two-thirds of a farmer’s gross income (from all sources) must be from farming activities. Meet this test and the farmer will be able to take advantage of the special farmer rules. Fail the test then different and less favorable estimated tax rules will apply.
Presuming a farmer passes the aforementioned rule and is indeed considered to be a farmer in the eyes of the tax law, the farmer has essentially three options to choose from in paying their taxes. All three options would be considered “correct”.
The first option would be for the farmer to ignore the special farmer rules and simply pay their tax in installments (generally quarterly) throughout the tax year. Not very many farmers choose this method (but a few do) because of the ability to hold onto their money longer under the other two options. The IRS, on the other hand, loves this method….
The second option (and the one traditionally used by most farmers) is for the farmer to pay all his or her tax in one lump sum. In order to be eligible to use this option, a farmer must pay the entire amount of tax due and actually file his/her tax return by March 1st of the year following the year for which the tax is due. For example, for the 2016 tax year, farmers choosing this method had a return due date of March 1st of 2017.
Finally, the third option is one in which the farmer is required to pay in two-thirds of his/her total tax by January 15th of the following year and pay the remaining one-third by April 15th. In this situation, the farmer doesn’t have to file his/her return until April 15th.
Option Three is becoming more and more popular with farmers (and in some cases, necessary) because many farmers have income from sources other than farming the amount of which isn’t known until after March 1st. A common example is farmers who have brokerage accounts which generate interest, dividend, and capital gain income. Generally speaking, the brokerage account statements usually don’t come out until the very end of February or sometime in March. The consequence of this is that it becomes practically impossible for the farmer to use Option Two because all his/her sources of income are not known by the March 1st required filing date.
In summary, all three estimated tax options are available to farmers. Which one best fits for any particular farmer varies according to each farmer’s individual circumstances. Working with a knowledgeable accountant on these matters is generally beneficial in order to choose the best option.
As is usually the case with tax law, there are many variables and nuances to consider in each taxpayer’s situation. Consequently, seeking the advice of an experienced, qualified tax professional is highly recommended.