The ramifications for farm operations of the 2017 Tax Cuts and Jobs Act (the new tax bill) that became law earlier this year are a mix of provisions that run the gamut from being beneficial to those that might be costly. What isn’t in short supply is the sheer number of changes you should be aware of as you prepare your tax return.
“Farmers have to evaluate the nuances of the new tax law even in this depressed ag economy,” explains Rod Mauszycki, DTN/The Progressive Farmer Taxlink columnist. “As a result of the changes, we generally don’t want to show losses, and we need to be aware that changes for federal taxes may have an impact on state taxes, as well.” Mauszycki is a principal with the Minneapolis-based tax and financial planning firm, CliftonLarsonAllen, which specializes in agribusiness and cooperatives.
Here are some of the areas of most concern.
> NEW DEDUCTION FOR PARTNERSHIPS, S CORPORATIONS AND SOLE PROPRIETORS
This new Sec. 199A deduction is not eligible for C corporations, only individuals and pass-through entities. The new tax law cut the top corporate tax rate from 35 to 21%, while those under other so-called pass-through entities only saw their top rate decrease from 39.6 to 37%. This new 20% deduction for sole proprietors and pass-throughs is seen as a way to level the playing field with the new cut for C corporations.
Additionally, under previous tax law, farmers were entitled to a deduction of up to 9% of net farm income known as the domestic production activities deduction (DPAD). The new law eliminated this deduction.
“This is going to be big,” Mauszycki says of the Sec. 199A deduction. “Farmers who are now C corporations will be asking themselves should they switch to a partnership or an S corporation. I’ve seen several clients for whom it will be worth it to make changes. 199A could be a substantial deduction that would be missed in a C corp.”
The deduction, Mauszycki explains, would help farmers better manage their tax liability and elevate the need for prepaids and unnecessary asset purchases to avoid tax. This may be a good time to convert to an S corporation and manage the built-in gains tax.
“On the bright side,” Mauszycki says, “even if the S corp was subject to the built-in gains tax, it would be at the new 21% rate.”
Essentially, qualified business income (taxable income) under one of the pass-through entities will get a 20% tax deduction that didn’t exist previously. Passive investment such as capital gains, dividends and interest income does not qualify for the deduction. The deduction is phased out for income above $315,000 (for joint returns) and $157,500 for individuals.
The new law eliminated the DPAD deduction for farmers and farming entities. However, it has essentially been kept in place for cooperatives under 199A(g). If a farmer sells to a cooperative, the cooperative can pass through 199A(g) deductions to its patrons as it did with DPAD. If the farmer or farm entity also sells to a noncooperative, he or she can also calculate an additional deduction under 199A.
Keep in mind that this 199A deduction will be determined after self-employment income is calculated. That means, even though it reduces taxable income, it won’t reduce self-employment tax.
> NET OPERATING LOSSES
Under old tax rules, what were known as “excess farm losses” offset farm income without limitation. The losses could be carried forward, and because the loss went on Schedule F, it offset income subject to self-employment tax. Mauszycki says that scenario was a “win-win” for farmers.
Under the new law, an excess business loss is not deducted on Schedule F, so it does not offset self-employment income. As a result, you’ll pay self-employment tax when these losses are used to offset farm income.
There is another downside. Beginning this year, a net operating loss can only offset 80% of taxable income as calculated before the net operating loss is applied. Previously, it was 100%. Mauszycki explains if you have a substantial loss in 2018 followed by a big profit in 2019, only 80% of 2019’s taxable income could be offset (assuming there were no pre-2018 net operating losses).
You can still carry back farm net operating losses two years, but the way loss rules work, a farm is limited to a $250,000 net operating loss ($500,000 for married filing joint).
“I think this will be a big surprise to some people,” Mauszycki says. “We can no longer carry the loss forward on Schedule F.”
As for the rules themselves, previously, a net operating loss could be carried back five years. Either that or you could elect to carry it back two years or carry it forward. Now, net operating losses can only be carried back two years, but losses can be carried forward an indefinite number of years (the carry-forward period was limited to 20 years previously).
> SECTION 179 EQUIPMENT AND DEPRECIATION
The amount of equipment and software that can be depreciated in a given year has been increased from $500,000 in 2017 to $1 million in 2018. The phaseout for the $1-million availability begins after equipment purchases exceed $2.5 million in a given year. However, beginning Sept. 28, 2017, until the end of 2022, 100% bonus depreciation applies to almost all purchases of farm property, including used property. The bonus depreciation phases out beginning in 2023.
Additionally, new farm equipment can now be depreciated over five years rather than the seven years previously allowed. However, used farm equipment depreciation continues with a seven-year life.
“One kicker is, under the new tax law, they took away 1031 tax-free exchanges for equipment,” Mauszycki says. “Now, these exchanges can only involve real property--essentially land.” So-called 1031 exchanges allow taxpayers to trade equivalent properties without a taxable event taking place.
Also new, equipment trades will now be considered as two transactions for tax purposes. Mauszycki uses the example of a farmer who trades in a piece of equipment worth $80,000 for a new version worth $100,000. Previously, the $20,000 difference, or boot, would have been the new amount depreciated on the tax return.
Now, instead, you recognize a gain of $80,000 for the sale of the old piece and have an expense of $100,000 for the new equipment that can be depreciated. “Financially, it still nets out in the end,” Mauszycki says, “but taxpayers need to be aware of it.”
There is an issue in that many states have an “add-back” provision that, for instance, would only allow the buyer of the $100,000 piece of equipment to recognize just a portion of the depreciation expense on his state tax return. Unless these states have made a “fix,” many farmers may be caught by surprise. In Minnesota, Mauszycki explains, 80% of that $100,000 would be recognized as income in the first year, and the remainder would be depreciated over the next five years. This is in contrast to prior years, when only the boot (not the entire purchase price) would be subject to the add-back rules.
“States generally don’t want you to accelerate the depreciation,” Mauszycki says. “They like to make sure they are collecting their revenue up front.” He expects that, come tax time, there will be considerable pressure in many states for legislators to revamp their tax laws to coincide with the federal law. That has yet to happen in many states.
> COMMODITY GIFTS TO CHILDREN
The big takeaway from the new tax law is that the benefits of making significant gifts of commodities to your children have been reduced. If children are subject to the so-called “kiddie tax,” they are now subject to the trusts and estate rates, not the parents’ rate. While this still saves self-employment tax, it subjects commodity gifts to much higher tax rates.
“In this case, you’d be better off to pay your children either in regular wages or by paying them wages in commodities, Mauszycki says.
In the past, parents would make gifts of grain to their children to pay for college expenses, for instance. If the child were in a lower tax bracket (usually the case), they would save the difference in the tax rate between child and parent, as well as not having to pay self-employment tax on the gift amount.
Under the new law, such gifts to children are subject to the same tax rates that apply to trusts and estate taxes. For instance, once a gift reaches $12,500 in value, any amount over that is taxed at 37%. Gifts of commodities will still allow a savings of not having to pay self-employment taxes, but that savings may well be eclipsed by having to pay more with the new taxes that apply.
> NO HOBBY FARMER ITEMIZED DEDUCTIONS
The law, for decades, has allowed hobby farmers (all hobbyists, actually) to claim itemized deductions for their hobby-related expenses up to the amount of income the hobby earned during the year. The remainder was considered a personal loss and was taken as an itemized expense. The deduction wasn’t necessarily lucrative because of restrictions on itemized deductions but was helpful.
The new tax law has completely eliminated the deduction for hobby expenses, along with all other miscellaneous itemized deductions. This provision is in force beginning this year and runs through 2025. You won’t be able to deduct any expenses from hobbies, but you do still have to report and pay tax on any income earned from a hobby.
“This may be a hard pill to swallow for guys with one foot still in farming who can’t quite leave,” Mauszycki says. “It won’t be worth spending $20,000 for that piece of equipment if you can’t deduct it.” He believes this provision might nudge some older farmers to cut ties completely with the operation.
Copyright 2019 DTN/The Progressive Farmer. All rights reserved.