Tax Bill Q&A for Agriculture

tax cuts and jobs actThe newly passed tax bill has numerous implications that businesses from all sectors need to understand and prepare for. Agriculture is no exception. The following guest blog courtesy of CliftonLarsonAllen provides a helpful Q&A on what the new tax bill means for farmers.

Should you wish to discuss tax reform and its impact on you or your business, please be sure to contact one of our fantastic member businesses with tax expertise.

Guest Blog from CliftonLarsonAllen

Now that President Trump has signed the Tax Cuts and Jobs Act bill, it is time to look ahead and start providing planning for our clients. Due to the numerous changes that affect farmers, a Question and Answer format for this release is appropriate. This is our attempt to answer most of the questions that preparers and farmers will have regarding the new bill. As usual, with any new law, there will be many provisions that require further guidance from the IRS. For those items, we will provide our commentary on what we think the answer may be. An additional release deals directly with the new Section 199A business deduction

Q: How does the new law affect my personal income tax rates?

A: There are still seven brackets, but some of the rates have been adjusted downwards. The 15% becomes 12%; the 25% becomes 22%; the 28% becomes 24%; the 33% becomes 32%; and the top bracket of 39.6% drops to 37%. The 10% and 35% brackets remain the same [Sec. 1(j)]. There are various changes to the breakpoints at which the rates become effective, but overall, tax rates have dropped by an average of 5-12%.

Q: Are these tax rate changes permanent?

A: No. These rates and brackets will revert back to current law beginning in 2026 [Sec. 1(j)(1)].

Q: Does the calculation of the inflation adjustment change?

A: Yes. Inflation-adjusted items will now be calculated using the Chained Consumer Price Index for All Urban Consumers (C–CPI–U) [Sec. 1(f)(3)]. This replaces the current C-CPI and will show a slower increase for inflation adjusted items. Over time, this can be material. Unlike other new tax provisions, this change is permanent.

Q: What happens to the standard deduction and exemptions?

A: The standard deduction is about doubled to $12,000 (single) and $24,000 (MFJ) beginning in 2018 [Sec. 63(c)(7)]. It then reverts back to current law in 2026. Personal exemptions are repealed until 2026 [Sec. 151(d)(5)].

Q: Are there changes to the kiddie tax?

A: Children receiving unearned income (capital gains, interest, dividends, etc.) in excess of $2,100 have been taxed at their parents’ marginal tax rate. That is, the child’s income was taxed at the tax rate as if added to the parents’ taxable income. If more than one child was subject to the kiddie tax, the income of all of the children was added to the parents’ income for purposes of computing the tax liability. This is changed.

Children under age 18 and certain children under age 24 will be taxed beginning in 2018 using the trust and estate income tax rate schedule [Sec. 1(g)]. Taxable income above $12,500 will be taxed at 37% [Sec. 1(j)(5)(B)(ii)(IV)]. Long-term capital gain and qualified dividends on taxable income in excess of $12,700 will be taxed at 20%, plus net investment income tax of 3.8%.

Q: What about the child credit?

A: The child credit is doubled to $2,000 [Sec. 24(h)(2)] and is refundable up to $1,400 [Sec. 24(h)(5)] and retains the current age requirement of 16 or younger. Additionally, there is a new $500 credit for dependents other than qualifying children that are not refundable [Sec. 24(h)(4)]. The credit phases-out beginning at $200,000 for single taxpayers and $400,000 for married couples [Sec. 24(h)(3)]. This also reverts to current law in 2026.

Q: What are the key changes to itemized deductions?

A: Key changes include:

  • Medical deductions are allowed in excess of 7.5% of adjusted gross income for tax years 2017 and 2018 and then revert back to the current 10% rule [Sec. 213(f)]. There is no AMT adjustment for medical expenses [Sec. 56(b)(1)(B)].
  • All state and local taxes (income or sales tax, plus property tax) are limited to an aggregate of $10,000 [Sec. 164(b)(6)].
  • Home acquisition mortgage interest is only allowed on up to $750,000 of indebtedness for new debt [Sec. 163(h)(3)(F)(i)(II)]. Old debt is grandfathered [Sec. 163(h)(3)(F)(i)(III)]. Interest on the second home is retained as a deduction. The deduction for interest expense on home equity indebtedness is suspended [Sec. 163(h)(3)(F)(i)(I)].
  • Cash charitable contributions are now allowed against 60% of AGI [Sec. 170(b)(1)(G)]. It repeals the deduction for certain college athletic event seating rights [Sec. 170(l)].
  • The phase-out of itemized deductions is suspended until 2026 [Sec. 68(f)].
  • Casualty losses are only allowed for designated disaster areas but revert back to current law in 2026 [Sec. 165(h)(5)(A)].
  • All miscellaneous itemized deductions subject to the 2% of AGI floor are suspended until 2026 [Sec. 67(g)].

Note – Almost all of these changes revert back to current law in 2026.

Q: Does the $10,000 limit on property taxes apply to farm operations or cash rental?

A: No. This only applies to the property taxes owed on your personal residence, any second home or other personally owned real estates such as investment real estate. All property taxes paid on a farm or farmland rented to a farmer is 100% deductible (subject to any at-risk and passive activity limitations) [Joint Explanatory Statement, Tax Complexity Analysis at 4.]

Q: What is the new tax rate for C corporations?

A: The current rate for corporations is 15% on the first $50,000, 25% on the next $25,000 and then higher rates thereafter. Starting for taxable years beginning in 2018, taxable income will be subject to a flat 21% tax rate [Sec. 11(b)]. For many farm operations, this will be a 40% tax increase.

Example – Many farm operations are structured as a partnership (for FSA purposes) with several corporate partners. By structuring it properly, these corporations will each report $50,000 at 15%. If there are three corporations, the total tax under the old law is $22,500 and it will now be $31,500 or an increase of $9,000 or a 40% tax increase.

Commentary – For financial statement purposes, since President Trump signed the income tax bill in 2017, all deferred taxes will be computed using the new 21% tax rate. This may result in a large adjustment to net income and in most farm operations, this adjustment will be positive. 

Q: What if I have a fiscal year corporation?

A: There will be a proration of tax rates, etc. based upon the days before January 1, 2018, and the days after that date [Sec. 15(a)(2)]. Therefore, if you have a September 30, 2018, year-end, you will calculate the taxable income from October 1, 2017, to December 31, 2017, at the old rates and after that date at the new rates. This will be based upon the number of days in each period.

Q: What is the new recovery period for farm equipment?

A: The current recovery period for farm equipment is seven years. Beginning with purchases in 2018, the recovery period for new farm equipment will be five years [Sec. 168(e)(3)(B)]. Grain bins, fences, and cotton ginning assets will continue to be depreciated over 7 years.

Commentary – Used farm property will continue to have a seven-year life. This may require a technical corrections bill if this was unintentional.

Q: How fast can we depreciate farm property?

A: Currently, most farm property is required to be depreciated using the 150% declining balance method. The new law allows farm equipment and certain other farm assets to be depreciated using the 200% declining balance method [Sec. 168(b)(2)]. Farm property with a life of 10 years or less will be allowed to use the 200% declining balance method (other than the straight-line required for orchards and vineyards placed in service). 15 and 20 year property will still require the 150% declining balance method.

Q: What are the new rules for Bonus Depreciation?

A: 100% bonus depreciation will now apply to all farm assets (other than land) placed in service between September 28, 2017 (about the only provision that applies to 2017) and December 31, 2022 [Sec. 168(k)(1); Sec. 168(k)(2)(A)(ii)]. Thereafter, the percentage is decreased by 20% each year and will reach zero in 2027 (unless extended before those dates) [Sec. 168(k)(6)].

Commentary – Unlike current rules that allow bonus depreciation on only new assets, this provision now applies to all assets acquired by a farmer. This is due to all farm assets having a recovery period of 20 years or less. However, for those farmers who have elected out of Section 263A or will elect out of the new business interest deduction rules, bonus depreciation is not allowed.

Q: What are the new rules for Section 179?

A: Beginning with taxable years beginning in 2018, Section 179 will increase to $1 million and the phase-out will start at $2.5 million. Section 179 is expanded to include [Sec. 179(f)]:

  • Assets used in the lodging industry such as beds, etc.,
  • Roofs,
  • HVACs,
  • Security systems, and
  • Fire suppression and alarm systems.

Q: Will Section 263A continue to apply to pre-productive costs?

A: If a farmer’s gross receipts are less than $25 million, Section 263A will not apply [Sec. 263A(i)]. This will allow farmers in this situation to deduct 100% of these costs as incurred.

Commentary – Farmers are also allowed to deduct 100% of the specified plants planted between September 28, 2018, and December 31, 2022, using bonus depreciation. For those farmers who elected out of Section 263A, we are uncertain if the new rules will allow them to “elect” back into Section 263A if their gross receipts are under $25 million. If so, this would allow farmers to take bonus depreciation on their farm assets and would not be required to use ADS. 

Q: What are the new rules for deducting business interest?

A: If a farmer’s gross receipts are under $25 million (after applying related party rules), there is no limit on deducting business interest [Sec. 163(j)(3)]. If receipts are over this level, then a farmer is limited to a deduction based on 30% of their modified income [Sec. 163(j)(1)]. Any excess is allowed to be carried forward [Sec. 163(j)(2)].

Modified income is essentially EBIDTA until December 31, 2021 when it becomes EBIT [Sec. 163(j)(8)(A)(v)].

Q: Is there a special election that allows farmers over the $25 million level to deduct business interest?

A: Farmers are allowed to elect to deduct 100% of business interest if their gross receipts exceed $25 million. However, in return, they are required to use ADS for assets with a recovery life of 10 years or greater [Sec. 163(j)(7)(A)(iii)].

Commentary – This provision was primarily provided for feedlot operators since their business model requires a lot of operating loans with low-profit margins. Also, it appears that most farm equipment with a recovery period of fewer than 10 years will be allowed to use 200% declining balance and bonus depreciation. The farmer will also continue to be allowed to use Section 179. This election is better than the election out of Section 263A due to ADS only being required on assets having a recovery life of 10 years or longer.

Q: What are the changes to lodging?

A: The House had proposed making lodging provided to owners of farm C corporations taxable compensation to the owners. However, this provision did not make it to the final bill.

Q: What are the changes to the meals deduction?

A: The primary change is that meals provided for the convenience of the employer to employees on the business premises will now be limited to a 50% deduction beginning in 2018 [Sec. 274(n)(2)] and will not be allowed to be deducted at all starting in 2026 [Sec. 274(o)].

Q: Can I continue to deduct 100% of my farming losses?

A: Section 461(j) was originally placed into the Code by the 2008 Farm Bill. This limited the deduction of farm losses to the greater of $300,000 or net farm profits during the previous five years. This applied if the farmer received certain USDA payments. This provision does not apply to C corporations.

The new law expands this to all non-C corporation business losses and places an overall limit on deductible business losses to $500,000 [Sec. 461(l) and removal of Sec. 461(j) effective for years beginning after 2017]. Any excess losses are added to net operating loss carryovers [Sec. 461(l)(2)].

Commentary – These new changes are actually worse than the old farm loss rules. The old rules allowed farmers to carry forward the excess to the next year’s Schedule F and offset SE income. The new rule includes it as part of an NOL which does not reduce SE income and is only allowed to offset 80% of taxable income. 

Q: What are the changes to net operating losses for farmers?

A: Under current law, farmers can carryback their net operating losses five years. They can also elect to carry it back two years or elect to carry it forward.

The new law changes this. Farmers can only carry their NOLs back 2 years or elect to carry them forward [Sec. 172(b)(2)(B)]. Also, the post-2017 NOL can only offset 80% of taxable income [Sec. 172(a)(2)] (similar to the current 90% of AMT taxable income rules).

Q: Can I continue to defer gain on farm equipment exchanges?

A: No. Beginning in 2018, you can only defer gain under Section 1031 exchanges for real property [Sec. 1031(a)(1)]. Personal property exchanges will require the farmer to report taxable gain on the sale of the asset based on the “trade-in” values. However, for federal purposes, the farmer will be allowed 100% bonus depreciation until 2023 and higher Section 179 limits.

Commentary – For federal purposes, this provision will be a net benefit in that farmers can now deduct the exchange value against self-employment taxes. However, if states couple to this provision, then substantial increases in state income taxes may arise on an exchange. 

Q: Are there any changes to self-employment taxes?

A: Other than changes in the amount income subject to self-employment tax, there has been no changes on what type of income is subject to SE tax. Therefore, cash rent landlords, crop share landlords and self-rental income will continue to be subject to current rules.

Commentary – The House had proposed substantial changes to self-employment tax. Although no changes were made in the final bill, it would not surprise us to see this come up as proposals in future tax bills. 

Q: What happened to estate taxes?

A: The lifetime annual exclusion amount has been doubled to $10 million indexed to inflation effective for estates of decedents dying between January 1, 2018, and December 31, 2025 [Sec. 2010(c)(3)(C)]. After that, it reverts to current levels. The exemption is indexed for inflation ($11.2 million for 2018). The annual gift tax exclusion of $15,000 (2018 amount) indexed to inflation remains in effect.

Q: What happened to DPAD?

A: In one word – Gone. It has been eliminated effective for taxable years beginning after 2017.

Q: What about changes to charity commodity gifts?

A: The importance of commodity gifts to charity may have been enhanced a bit by the increase in the standard deduction. Under the old law, farmers who do not itemize could donate about $12,000 to charity, reducing their self-employment and taxable income. Under the new law, the same couple could donate about $24,000 and achieve similar tax savings. (Gifts in excess of these amounts receive the benefit of itemized deductions. However, commodity gifts reduce the exposure to self-employment tax.)

Commentary – The new Section 199A deduction will reduce the benefit of commodity gifts to charities slightly. By reducing farm income by the amount of the gift, the farmer will essentially only get an 80% tax deduction because they are forgoing the additional 20% Section 199A deduction. However, this will be offset by the amount self-employment tax saved on the gift. 

Q: What about changes to commodity gifts to children?

A: Because the Kiddie Tax now applies the trusts and estate tax rates to children, the benefit of giving commodity gifts to children is substantially reduced. In many cases, the child will owe tax up to 3 times higher than the parents.

Example – Assume a farmer gifts $15,000 of grain to his child who is in college. If the farmer is in the 12% tax bracket, the gain to the child would be taxed at 12% under old rules. Under the new tax law, some or all of the gain would be taxed at 37%.

Commentary – Payment of commodity wages will provide a better benefit to children than commodity wages assuming the child has performed enough work. The effect to the farmer will be the same (e.g. reduction in self-employment taxes) and the wages will be subject to the child’s tax rate, not the higher trusts and estates tax rate.

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