Note: All pictures taken from IRS.gov
Sometimes it's tempting to lock ourselves on our farm, grow all our own food and chase the tax man away with our shotgun. The problem is that we live in a complex society and most of us don't want to give up things like public roads, schools, parks, police, social security and the strongest military in the world. We don't always agree with how our government spends our taxes but that's a different problem. The concept of taxes is a necessary part of any society and everybody needs to do their share.
My big problem isn't with taxes in general, it's with the horribly complex U.S. income tax code. Nobody completely understands the tax codes, not even the people that wrote them. Have your taxes prepared by two different accountants, you'll get two different amounts on your tax return. Get audited and it's practically guaranteed the auditor can find ways to increase the amount of taxes you owe.
Tax Forms A-Z
I've almost always done my own taxes. It's easy when you're younger, simply fill out IRS Form 1040-EZ and get all your money back. Well, not all of it. That's the first thing I learned about taxes, just because you get a refund check doesn't mean you didn't pay taxes. Most refund checks are only a small portion of the total taxes you paid, it's the amount you over-paid. And no matter how little you earn, you can't get a refund of the social security or Medicare taxes you've already paid.
Get a little older and start making more money, you soon move up to IRS Form 1040-A.. It's a little more complex but still not too bad. Buy a house and you'll probably be filing Form 1040. It's even more complex but worth the effort in order to itemize your deductions (Schedule A) so you can deduct more income and pay fewer taxes. If you make over $1500 in taxable interest or dividends, you'll end up filing Schedule B. Earn some capital gains and you can add Schedule D to the list. All those schedules are more paperwork but they're also a sign that you're making more money and generally doing well in life.
Owning a Kona coffee farm has increased our tax complexity in two major ways. The business side of things (selling the coffee) has a huge set of rules while the farm side of things (growing the coffee) has a completely different huge set of rules. The rules aren't always clear and parts were obviously written by accountants, not farmers. For example, in 2006 I purchased a $284.35 weed whacker for use on the farm. Since it is a farming expense I can deduct the cost of that weed whacker from my taxable farm income. The question is, how exactly should it be deducted?
Schedule F (farm expenses), line 30 is for deducting the cost of "Supplies" but there are no instructions for line 30 so it's anyone's guess what qualifies as supplies and what does not. Most supplies such as feed, fertilizer and fuel have their own lines. Line 27 is for "Repairs and maintenance" which may not sound like a good place to deduct the cost of supplies but read the instructions for line 27 and they explicitly state "You can also include what you paid for tools of short life or minimal cost, such as shovels and rakes." A weed whacker is kind of like a shovel or rake.
I spoke with a tax accountant that said a good rule of thumb is "2 and 2": if an item costs less than $200 and is expected to last less than 2 years, it should be considered a supply. Anything larger should be considered tangible property and needs to be depreciated over several years. The IRS publishes a Farmer's Tax Guide which says "If you buy farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year." The accountant said two years but the IRS says one year.
Reading the tax codes as closely as I can, it would appear that the weed whacker should be considered "Farm machinery and equipment" which under the IRS's General Depreciation Schedule has a recovery period of 7 years. In other words, they expect my weed whacker to last 7 years. That may make sense if the weed whacker were being used on a tax accountant's front lawn but this year's weed whacker is to replace the one we purchased last year which has already given up the ghost as is beyond its "useful life." So now what happens to the six years of deduction remaining on last year's weed whacker? I'll leave the answer to that as an exercise for the reader.
The local extension office held a class for farmers all about taxes. The tax expert teaching the class said learning the tax codes is kind of like learning French, things don't always make sense so don't ask why or you'll never be able to get anywhere, simply accept it as being the way it is and move on. Unfortunately that still doesn't tell me how to deduct my $284.35 weed whacker.
Two deductions I probably qualify for but chose to skip were home office expenses and vehicle expenses. These are two areas that are often abused by small business owners and some believe them to be red flags that increase the chances of an IRS audit. Since my truck, computer and a handful of other items qualify for both farm use and personal use, I could probably claim a partial deduction for these expenses. However some back of the envelope math convinced me that the little money I would save isn't worth all the extra effort and the possible increase risk of an audit. In a sense, I paid the IRS about $100 so I could skip the paperwork on those deductions.
Another missed deduction is my tax preparation fees (schedule A, line 21). The instructions don't explicitly prohibit it but I'm guessing I'm not supposed to deduct the week's worth of my time I spent trying to figure out the convoluted tax codes. Maybe I should do like so many other people and simply collect a pile of receipts then hand them all over to an accountant at the end of the year. Maybe I'm paranoid or maybe I'm just being self-sufficient, either way I don't like the idea of blindly trusting my finances to someone I hardly know. By the time I figure out my income and expenses enough for the tax accountant, I feel like I might as well just do the rest myself.
Our first year on the farm I did the taxes myself then hired an accountant to see if he came up with the same answer. Two weeks and $276.04 later, he said I owed the IRS a preposterous amount of money. The problem was the capital gains from selling our previous home. Unwilling to take his word for it, I looked up the IRS rules for myself. It took a few hours but I finally found very clear wording in IRS publication 523 that showed those capital gains as exempt. The expense of hiring a tax accountant is often justified by saying they'll find hidden deductions the average tax payer would miss. In my case, the opposite was true. The amount I saved myself that single year has more than paid for the time I've spent wrestling with my taxes all the other years.
Congress does occasionally try to "fix" or at least simplify the tax code. One idea currently being considered by congress is the FairTax (one word, no space). It is a proposal to abolish the current federal tax system (yippee, no more IRS) in favor of a national retail sales tax (gotta pay taxes somehow). The theory is that wealthy individuals tend to spend more so they'll pay more taxes while, because of a monthly "tax rebate" check, poor folks could live basically tax free. The federal sales tax would be 23% which seems like a bargain compared to the 25% to 35% most people pay in income taxes now. No paycheck withholdings, no forms to file, no tax loopholes for the uber-rich, it sounds like a great system! Yet I suspect it will never pass and never will any other "let's dump the tax code" idea. Let me explain why.
It would be nice if the tax codes were simpler. Instead, every year they get filled with more rules and exceptions. Consider GO Zone property. The Farmer's Tax Guide says GO Zone property qualifies for "an additional 50% special depreciation allowance ... after any section 179 deduction and before regular depreciation under MACRS." Apparently this is supposed to be obvious to any farmer that has read chapter 3 of publication 946.
GO Zone stands for Gulf Opportunity Zone which covers areas hit by hurricanes Rita, Wilma and Katrina (and will probably be extended for whatever hurricanes come next). Basically, the special depreciation allowance is a tax break for reconstruction projects in the hurricane affected areas. It is difficult for congress to find, allocate and manage direct funding for things like hurricane relief projects. On the other hand, adding a new tax deduction is relatively easy and accomplishes basically the same thing. Besides, the United States is a capitalist democracy so isn't it better to encourage the private sector instead of creating yet another government bureaucracy? Adding a new tax law is a handy way to pay for today's problems with tomorrow's money. Congress doesn't have to come up with a dollar amount but still gets to go home and talk about all the good they did. Why would congress ever want to get rid of a system like that?
As much as I hate having to spend hours doing my taxes every year, I recognize that taxes will never go away. It's like learning French, it may not make sense but it is the way it is, I have no choice but to accept it and move on. The good news: this year we owed $0 in taxes. It's too bad every year can't be like that.
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