By: Paul Neiffer, The Farm CPA Blogger
Now that President Donald Trump has signed the Tax Cuts and Jobs Act, it’s time to dig deeper into the details and see how it affects most farmers. As with any major tax change, there will be winners and losers. But overall, I would label this new law as a winner for the ag industry.
Child Tax Credits
The child tax credit has been doubled to $2,000. If you do not have enough tax, there will be a refund of up to $1,400 per qualifying child. Other dependents not qualifying for the $2,000 credit will receive a $500 nonrefundable credit.
Income Tax Rate Changes
Other than the 10% and 35% tax bracket, all the other tax rates have been lowered. The reduction ranges from about 15% to 25% on income between $20,000 and $400,000 for married couples. The only range where we see rates go up or stay the same is a narrow window between $400,000 and $480,050. Once a married couple reaches this threshold, the old top rate of 39.6% is reduced to 37% thereafter. Unless extended by Congress, these lower rates revert to current rates in 2026.
Itemized Deductions and Exemptions
Where the new tax law gives you a benefit through lower rates, it removes some of it by making changes to itemized deductions. It removes the deduction for personal exemptions. For a farm couple with four children, this eliminates about $25,000 of deductions. To help offset this, it almost doubles the standard deduction (up to $24,000 for married couples and $12,000 for singles).
However, if you are in a state with an income tax, the new bill caps the aggregate of personal state and local income taxes, property taxes, etc. to $10,000. The property taxes paid on your farm operations and rented farmland continue to be fully deductible.
If you purchase a new house after Dec. 15, 2017, you can only deduct the interest on a mortgage of up to $750,000. The old limit allowed a deduction of up to $1 million of mortgage indebtedness.
All miscellaneous itemized deductions have been eliminated. Medical deductions can be deducted based on the excess of 7.5% of adjusted gross income for 2017 and 2018 instead of the current 10% limit. Most of these provisions expire Dec. 31, 2025, unless Congress extends them.
Section 179 is bumped to $1 million and is effective for tax years beginning in 2018. The phase-out level is also increased to $2.5 million and will be indexed to inflation.
Bonus depreciation has been substantially enhanced. Beginning Sept. 28, 2017, and through Dec. 31, 2022, 100% bonus depreciation applies to all purchases of farm property, including used property. After 2022, bonus depreciation ratchets down by 20% each year and expires at the end of 2026. Transactions between certain related parties and certain elections by farmers (more on that in a moment) continue to disallow any bonus depreciation.
New farm equipment can be depreciated over five years, instead of the current seven. Used farm equipment continues the seven-year life. Farm equipment and certain other farm assets can now be depreciated quicker than under the old law (200 declining balance instead of 150 declining balance).
Growers that plant new trees in orchards or new vines in vineyards can fully deduct these costs using bonus depreciation.
Certain Employee Fringe Benefits
Farm employers can provide housing and meals to their employees. If the entity was a C corporation, they could provide these same benefits to owners and still deduct the expenses and have it be tax-free to the owners.
The House had proposed eliminating this benefit for housing, however, this did not get into the new bill. Therefore, this benefit is still allowed.
Meals provided on the farm are now subject to a 50% deduction (instead of 100%) beginning in 2018 and will be no longer be allowed as a deduction beginning in 2026.
Net Operating Losses
Under the old law, a farmer could carry back their net operating loss five years. They could also make an election to either carry it back two years or forego the carryback completely and simply carry it forward. The new law only allows a farmer to carry back their net operating losses two years or elect to carry it forward.
The old law limited the carryforward to 20 years. But the new law allows for an indefinite carryforward period.
Under the old law, farmers could offset all of their taxable income with a net operating loss. The new law lowers that to 80% for farmers. However, any net operating losses created before 2018 will be able to fully offset taxable income.
Limitation on Business Losses
Under old law, farmers were only limited on the amount of loss they could show on a tax return if they received a Commodity Credit Corporation loan through USDA’s Farm Service Agency. Under the new law, all taxpayers are limited to showing an aggregate loss of $500,000 each year. If the farmer exceeds that amount, the excess is carried forward as part of a net operating loss, which is only allowed to offset 80% of taxable income. Therefore, the maximum amount a farmer can carry back beginning in 2018 is $500,000.
Reduction in Corporate Tax Rate
The old top corporate tax rate was 35%. The new rate is 21%, or a 40% reduction. For many farm operations, though, this is now a 40% tax increase because they primarily only paid tax at the old lower tax rate of 15%. For example, suppose four corporations hold equal ownership of ABCD partnership. The taxable income for each corporation is $200,000. Under the old law, each corporation only paid $7,500 of tax or $30,000 total. Under the new law, each corporation will now owe $10,500 of tax and $42,000 in total, representing a 40% tax increase.
The New Section 199A Deduction
Under the old law, farmers were entitled to a deduction of up to 9% of net farm income known as the domestic production activities deduction (DPAD). The overall limit was 50% of wages paid and a final limit of taxable income. It could not create a net operating loss.
The new law eliminated this deduction. However, it did create a new Section 199A deduction designed to level the playing field between corporations, which saw their top rate go from 35% to 21%, and pass-through farmers, which would only have seen their top rate decrease from 39.6% to 37%.
There are two components to the deduction. First, on sales to non-cooperatives, a farmer is allowed a 20% deduction based on net farm income and net taxable income minus net capital gains and cooperative distributions. Once that deduction is calculated, the farmer can add 20% of gross coopera-tive payments received as a patron. The only limit is taxable income minus net capital gains.
We will need guidance from the IRS regarding farm landlords (cash or crop-share) and self-rental arrangements to see if they will qualify for the new 20% deduction. A literal reading of the new code requires a trade or business and typically neither of these qualify.
Because corporations got the benefit of lower rates, they’re not allowed to take this deduction. That is unlike the old law, under which corporations were eligible for DPAD. This deduction will expire at the end of 2025.
Analysis will be needed to determine which entity structures are best with this new deduction. See my next column for analysis on this deduction.
Enhancement of the Cash Method of Accounting
Unless a farmer operates within a family C Corporation with greater than $25 million of revenue (or operates as a partnership with this type of corporation as a partner), all farmers can use the cash method of accounting. The new tax law provides some new enhancement for both farmers and non-farmers.
Now, any entity with revenues of less than $25 million can use the cash method of accounting. Many farmers have non-farm operations that, under the old law, required the accrual method of accounting. The new law allows them to switch to the cash method as long as their revenues stay under $25 million.
Many of our orchardists and vineyard owners were required under Section 263A to capitalize preproductive costs and to not start depreciation until the trees or vines came into production. The new law allows farmers with revenues under $25 million to ignore Section 263A and fully deduct all costs as incurred.
We are not sure if farmers who originally elected out of Section 263A will be able to now elect back in and use this provision. These farmers were required to use ADS (including certain related parties) for all farm assets and could not take bonus depreciation. We need guidance from the IRS to determine if they can take advantage of this provision.
Business Interest Deduction
Farmers under the old law were always able to deduct business interest related to their farm operation, including the purchase of farmland.
Under the new law, if a farm operation has gross receipts greater than $25 million, including certain related parties, then interest deduction will be limited to 30% of adjusted net income. From now until 2022, farmers can add back interest, income taxes, depreciation and amortization (EBITDA) to arrive at adjusted net income. After that date, farmers will not be able to add back depreciation and amortization (EBIT).
However, a farmer can elect to fully deduct interest. The trade-off is farmers must use the Alternative Depreciation System, which has a longer life, on all farm assets with a recovery period of 10 years or longer, and they can’t take bonus depreciation on these assets. This provision was included to help feedlots that rely on borrowed money to purchase cattle and have very low margins.
Commodity Gifts to Kids
Under the old law, if the kiddie tax did not apply and a child was in a lower bracket, he or she could also save the difference in the tax rates and save on self-employment taxes. The kiddie tax would prevent income tax savings but allow for self-employment tax savings.
The new law now subjects children subject to the kiddie tax to much higher taxes. They are subject to the trusts and estates tax rates, which are 37% once income reaches $12,500. Therefore, if the child is subject to the kiddie tax, commodity gifts to kids have become much more expensive. You might save tax on self-employment but be hit with much higher income taxes. Likely, only farmers in the highest tax bracket will continue to make commodity gifts to kids.
Paying appropriate wages to children under age 18 for Schedule F farmers will achieve the same self-employment tax savings, and this income is taxed at the child’s tax rate and can be used to fund a Roth IRA.
Estate Tax Changes
The lifetime estate and gift tax exemption for transfers after 2017 and before 2026 has been bumped to $10 million indexed to inflation. It will be $11.2 million in 2018. Farmers with a net worth over $10 million should strongly consider making gifts over the next few years to take advantage of this expanded exemption.
For More Tax Bill Analysis
Read the latest news about the new tax bill on Paul Neiffer’s “The Farm CPA” blog. Through his blog, he provides analysis and insights to farmer tax questions. Visit agweb.com/blogs