One of the best ways for a Christmas tree grower to improve farm cash flow is to pay estimated taxes at the right time.
Christmas tree farming is an extremely seasonal business, with almost all of a choose-and-cut grower’s income being earned in a few weeks in November and December. Wholesale growers similarly have irregular cash flow, but may have a slightly more even distribution depending on when deposits are paid and balances are due.
Paying estimated taxes at the right time will improve cash flow in the months without revenue, lessening the burden on a grower to pinch pennies or use a line of credit to pay necessary expenses.
General Rules
As a general rule, the IRS requires taxes to be paid evenly throughout the year. For example, if an individual is an employee, regular tax payments are easy because the employer withholds tax payments from each paycheck and sends the amounts to the IRS.
Estimate Due Dates
Self-employed individuals, such as Christmas tree growers, must similarly make regular estimated tax payments to the IRS. Generally, the IRS requires four estimates by the following dates each year for individuals:
Please note that the due dates above and information in this article applies to individuals, whether they are sole proprietors or owners of a pass-through entity (non-taxable entity), such as an LLC, partnership, or S-corporation. C corporations are similarly required to make estimated payments; however, the rules differ slightly and are outside the scope of this article.
Underpayment Penalty
If a grower does not pay enough in estimated taxes to cover his tax bill, he may incur an underpayment penalty. Generally, a grower will not incur an underpayment penalty if he timely pays at least 100% of his prior year tax liability (110% if AGI > $150,000) or 90% of his current year tax liability. It is safest to base the estimates on the prior year tax liability because it is often difficult to accurately estimate current year income and tax.
Required Payment Example
Doug Firr had a total tax liability of $15,000 in 2019. Doug Firr has a total tax liability of $17,500 in 2020, with an AGI of less than $150,000.
Doug is required to make estimated payments totaling the lesser of (1) 100% of his 2019 tax liability of $15,000, or (2) 90% of his current year tax liability of $17,500, which is $15,750 (90% * $17,500).
Doug is required to pay at least $15,000 in estimated payments to avoid an underpayment penalty in 2020.
Estimated Tax Penalty
The underpayment penalty can also apply if a grower does not make payments throughout the year when income is earned. For example, a Christmas tree grower also sells a significant number of balled and burlapped trees in Spring for landscaping. The grower will likely incur a penalty if he only makes an estimated tax payment on January 15 of the following year because he did not pay a timely estimate for the Spring B&B tree sales.
The B&B example brings up an important point. A grower should not have to pay estimated taxes when he has not earned any income. Fortunately, the IRS has two exceptions to the general rule that estimated taxes must be paid in four equal installments throughout the year.
Exceptions to the General Rule
1) Farmers and Fishermen
The IRS has a special rule for farmers and fisherman because income from farming and fishing can vary greatly from year to year.
To be considered a “farmer,” at least 66.66% of a Christmas tree grower’s total gross income as shown on the tax return must have been from farming activities for the current tax year or the prior tax year. Christmas tree growing is considered “farming,” as well as other farming activities that involve cultivation or raising agricultural commodities, such as growing crops or raising livestock.
If a grower is considered a “farmer” for estimated tax purposes, then the IRS only requires one estimated tax payment, due on January 15 of the following year. The required estimate amount (to avoid a penalty) is the smaller of (1) 66.66% of the grower’s current year tax or (2) 100% of the grower’s prior year tax.
Alternatively, a farmer does not have to make the January 15 payment if he files his individual tax return and pays all taxes due by March 1. If a grower is unsure if he will be able to file his tax return and pay the entire balance due by March 1, he should make the January 15 payment.
“Farmer” Exception Example
Doug Firr is a Christmas tree grower who earned $75,000 from Christmas tree growing, $20,000 from raising livestock, and $30,000 from a part-time, non-farming job in 2020. Doug is considered a “farmer” in 2020 because at least 66.66% of his total gross income was from farming activities ($95,000 / $125,000 = 76.0%).
Doug is only required to make one estimated payment on his $125,000 gross income, due January 15, 2021. Alternatively, Doug could forgo the January 15 estimated payment by filing his tax return and paying the entire tax due by March 1, 2021. Either way Doug avoids an underpayment penalty.
2) Annualized Method
If a grower does not qualify as a “farmer” because he has income from other sources (such as wages, interest, or dividends) that exceeds 33.33% of his total gross income, the grower may still be able to avoid an underpayment penalty and improve cash flow by using the annualized method.
The calculations for the annualized method are complicated; however, the method generally only requires a payment when a grower earns income. A grower takes his income for a quarter (or other period of time) and annualizes it to calculate an estimated total year income. A grower would then owe an estimate based on the annualized total year income. An IRS worksheet from Publication 505 regarding the annualized method can be found here.
If a grower does not earn any income from his farm during a quarter, an estimated tax payment is not required for the farm income. However, a grower might still owe an estimated tax payment based on other income he has for that quarter.
Conclusion
All Christmas tree growers should attempt to improve their cash flow in months without revenue, and paying tax estimates at the right time can significantly improve a grower’s cash flow.
This article is just an overview of estimated taxes. There are many more nuances that a Christmas tree grower should review with an accountant to determine the best time to make estimated tax payments for his individual situation.
As always, feel free to reach out with any questions or comments!
