Don’t Prepay 2018 State Income Taxes (And Paul Makes a Mistake)

When it became apparent that state income taxes would either (a) not be deductible or (b) there would a be a limit of $10,000 on the deduction, many commentators suggested prepaying 2018 income taxes by December 31, 2017 in order to obtain a deduction.  Our firm had researched this issue and could find no authority for allowing this deduction and we found authority against it.  We now no longer have to worry about whether it would be allowed or not.

In the Code Section dealing with the deduction of individual state income taxes, there is a specific provision that indicates any 2018 state income taxes paid before 2018 will be treated as if it were paid in 2018.  Therefore, make sure you do not prepay any 2018 state income taxes since you will be out the money for over a year and won’t get a deduction.

If you do itemize for 2017, you for sure should go ahead and prepay your remaining 2017 state income taxes.  However, if you will be in the alternative minimum tax situation, skip prepaying your state income taxes since you will get no net tax benefit for the prepayment.  In that case, simply pay them in 2018 as you normally would.

One option that may save you a little bit is if you prepay your 2017 state income taxes and end up with a state tax refund in 2018.  This is due to tax rates being higher this year when you deduct the tax and lower next year when you are required to report the refund as taxable income.  Let’s look at a quick example:

Bill and Sue Farmer have taxable income of $300,000 for 2017 which puts them right in the middle of the 33% tax bracket.  They prepay their state income taxes and receive a refund of $10,000 in 2018 when their income tax bracket will be 24% on the same amount of taxable income.  Prepaying the state income tax this year saves them $3,300 and costs them only $2,400 next year for a net tax savings of $900.

You would need to be careful not to prepay too much state income tax.  The IRS could assert that you did not pay an actual liability owed; but if you are over by less than 10% or so, there should be no issues.

Now for Paul’s Mistake – In my post yesterday, I showed an example of how the 20% special farm income deduction would be limited and I made a mistake.  Here is the original example:

As an example, assume a farm earns $500,000, pays wages of $125,000 and has original asset cost of $2.5 million.  The gross 20% deduction is $100,000. It is limited to the greater of (1) $62,500 ($125,000 X 50%) or $125,000 ($125,000 X 25% plus $2.5 million X 2.5%).  Therefore, the farmer could deduct the full $100,000. 

My mistake was in the calculation of the second limit.  $125,000 times 25% is only $31,250 and added to $62,500 for the 2.5% of $2.5 million my calculation should have been $93,750.  Instead of being able to deduct the full $100,000, the farmer would be limited to $93,750.  However, this is still $31,250 higher than the first option of 50% of wages paid.

Finally, I have gotten some questions regarding deducting interest for your farm operation.  If your gross receipts from farming is less than $25 million, then you can fully deduct all of your business interest.  If you are over $25 million, you can make an election to deduct 100% of your business interest.  In return, you are required to depreciate all assets with a 10 year life or greater using ADS (a longer system) and you can’t take bonus depreciation.  This is a special provision for farmers and does not apply to cash rent landlords.

  • Principal
  • CliftonLarsonAllen
  • Yakima, Washington
  • 509-823-2920

Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Yakima, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. In fact, Paul drives combine each summer for his cousins and that is what he considers a vacation. Leave a comment for Paul. If you would like to leave a comment for Paul, follow the link above, however, please make sure to include your email address so that he can reply to your comment (your email address will not automatically show up).

Comments

What about prepaying Illinois real estate taxes?

One reading of the conference report would indicate that the deduction is limited to the 2017 actual liability not just the fact a taxpayer, in good faith, made an estimate that was in excess of their liability. In other words, for 2017, the taxpayer is on the “accrual”method.

I would have the same question as the one from WI. The new tax bill would have no jurisdiction over what I file in 2018 for the 2017 tax year.

Paul,
Can you recommend a ranchers cpa in the phx area? Or how do we hire your services to look at our succession plan for our family ( I am a 55 yr old daughter) or hire you for our portion of investment in the existing ranch and taking full depreciation deductions and all expenses possible when only owning one of two ranch land leases, 1/2 undivided owners of 75 private acres and 10% of herd (750).

Paul,

We live in WI which has for years allowed prepayment of WI income taxes via Form W-200 with the taxes deductible for example in 2017 for a prepay of 2018 WI taxes. WI then issues a letter to give your employer telling the employer NOT to withhold WI income taxes as they have been prepaid for the upcoming year. Are you saying these prepayments are now not allowed even though WI has had this provision for years?

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