Tri-State Neighbor: South Dakota Farm Newspaper

Dear Michael: We still have quite a bit of our grain left that we haven't sold - almost 20,000 bushels of wheat for sale. We have been debating over whether we should sell the wheat and defer payments over the next four years or if we should just sell it all at once. If we spread it out over four years, we will only have $125,000 per year in income versus the $500,000 all at one time. Which is better? We are leaning toward deferring because it just seems to make more sense. But, of course, you always come up with an angle we've never thought about. - To Defer or Not To Defer, That is The Question!

Dear To Defer: First of all, you have to consider the layered nature of income taxes and how each additional layer of income is taxed at a higher rate. Some are minimal increases and others are quite substantial.

Here are the tax brackets:

Married Filing Jointly

€10 percent on the income between $0 and $16,050.

€15 percent on the income between $16,050 and $65,100; plus $1,605.

€25 percent on the income between $65,100 and $131,450; plus $8,962.

€28 percent on the income between $131,450 and $200,300; plus $25,550.

€33 percent on the income between $200,300 and $357,700; plus $44,828.

€35 percent on the income over $357,700; plus $96,770.

In order to understand what tax bracket you are in, you take all the income you normally receive (including dividends and interest on investments). Now we add on this “extra” income of either $125,000 (the four-year deferral) or the $500,000 in one shot.

Now that you've got your totals, remember, we also get to take your deductions. Grab some of your old income tax returns and see what your average deductions have been over the years. Maybe you've got some depreciation left, and probably you'll still have ongoing expenses of gasoline, fertilizer or weed control.

Just because you stop farming doesn't mean some of the deductible expenses of owning a farm go away. You still have to maintain your farm acres and those expenses are deductible as long as you are still earning active earnings, such as this grain.

Now you have the comparison between if you take the earnings all in one year versus spreading them over four years.

However, there is a twist and this is the most important consideration. For every year you take earnings, you have to pay Self-Employment Taxes (which are Social Security and Medicare) up to $94,200 per year in earnings. This rate is 12.4 percent of all income up to $94,200 and then no taxes for any earnings above this amount.

Before, you were undoubtedly feeling smarter taking the income over four years, but now have to subtract from the four-year number of cumulative taxes the taxes of 12.4 percent of $94,200 times for three more years. In essence, just subtract another $35,040 from your cumulative taxes, if you're using a four-year deferral.

I'm guessing this will bring these two numbers much closer together.

Now, let's add the final piece of the puzzle. If I have the money on the lump sum and invest this money for the four years it takes me to receive the payments on the four-year payment plan, what would be your end result at 3, 4 or 5 percent - whatever percent you think you can attain? Then take the four-year payments and take each year with interest and adding an additional principal payment each year to see your end result on the four-year plan. I can do this whole thing in about a half hour for you, if you want to come in and see me.

Some variables to also consider: Will income taxes stay at the levels and rates they are today or will a new Congress and president commence a change in the tax rates? Will IRS someday decide that deferring income no longer qualifies as not earning the income in a given year? It may be if you take interest on your deferral account from your elevator, this will immediately draw IRS' attention and cause the income to be taxed in the first year in any case.

I'm still looking into this bit of information for confirmation.