Overview of Tax Law Changes for Ag Operations
As I wrote an article on possible tax reform back in October 2017, it seemed like it was still a long shot. Now we have signed legislation that really is a significant change to the tax structure … at least for a while. Most of the individual tax changes will “sunset” in 2025 or return to current law if Congress doesn’t act again to extend or make the changes permanent. Most of the provisions only affect future years so we have some time to digest all the changes and really understand the impact. Following is an overview of some of the changes that may affect ag operations.
Increased Standard Deduction
The 2017 Tax Relief Act sets the standard deduction at $24,000 and eliminates the personal exemption. This will significantly reduce the number of individuals who itemize their deductions and simplify many tax returns. The 2017 standard deduction was $12,700 for Married Filing Joint Returns. With the elimination of personal exemptions, the child tax credit was increased to $2,000 per child and the family income limit was increased so more families will qualify. The personal exemption amount in 2017 was $4,050 for each member of the household. In general, your family size and the age of your children will largely determine whether this combined exemption will increase or decrease your tax bill.
Change to the Individual Tax Rate Structure
The law retains seven brackets and a marriage tax penalty. (Two individuals can make more money at a lower rate than a married couple.) The maximum rate has been reduced from 39.6% to 37%.
Alternative Minimum Tax (AMT)
The original house proposal would have eliminated the AMT tax. This tax was imposed many years ago with the idea that it kept high-income taxpayers from taking advantage of too many tax benefits. However, the limits were not indexed for inflation and the levels where the AMT tax would kick in started to affect many taxpayers. Instead of full repeal, the compromise bill increased the limit again so fewer taxpayers will be subject to the tax. Without full repeal, it doesn’t really simplify the tax code.
Interest and Real Estate Taxes
We have fielded more questions about the elimination of interest and real estate taxes than anything else over the past few months. It is important to recognize that not all interest and real estate taxes are the same. The discussion of elimination of these came mostly from Schedule A (Itemized Deductions). For most farmers, these are the Real Estate taxes paid on the house and mortgage interest on the house. This had nothing to do with business interest or real estate taxes paid on your farm real estate.
There is a provision to limit interest on businesses that gross more than $25 million. This could affect cattle feeders and other large operations. There are some rules that will allow these businesses to still deduct interest. If this affects you, you will want to work with your tax preparer to see what you need to do.
Estate and Generation-Skipping Taxes
The house proposal eliminated the “death” tax and the generation-skipping transfer taxes while retaining a full step-up in basis. However, the proposal didn’t make the compromise bill. The compromise doubles the exclusion per person from $5 million to $10 million, but only through 2025 so we are back to dealing with an unknown. Since few of us know exactly what year we are going to die, it is really hard to plan on anything other than the $5 million per person exclusion. The rates will continue to be indexed for inflation so the actual amount a person can pass on in 2018 will be $11.2 million. This increase is beneficial, but without a permanent law, it is really just a benefit for a few years.
New Tax Rate for Small Businesses
There has been a lot of discussion about the pass-through business income. This includes S-Corps and Partnerships as well as Schedule C and F businesses. The compromise has settled on a 20% deduction for your farm income. For example, if you recognize $100,000 on your Schedule F, you will automatically get a $20,000 deduction. This effectively lowers your tax bracket by 20%. If your total income is over $315,000, the deduction starts to get complicated. The final regulations on this new law will be interesting as it gets unveiled in 2018.
New Tax Rate for Corporations
The corporate tax rate (for C-corporations) will be a flat 21%. For many with C-corporations, this will actually be a tax increase since we are used to using the 15% bracket. However, when it comes time to recognize more income (high profit years, liquidation, etc) it will be very nice to have a cap at 21% instead of the max rate of 39%.
Section 179 and Bonus Depreciation
The new law sets the Section 179 deduction at $1 million (up from $500,000) and raises the purchase phase out to $2.5 million. As most producers weren’t reaching the maximum deduction when it was $500,000, this is not a major change. The new law does reinstate bonus depreciation at a rate of 100% through 2022. For those of you looking to put up a building, this may be a good time. The law also changed the rules so bonus depreciation will apply to both new and used property.
Elimination of the Section 1031 for Personal Property
We often think of 1031 Exchanges being for real estate, but actually that part of the code section is regularly used on farm returns with equipment trades. The new tax law eliminates the ability to use this section for personal property (equipment). When you trade tractors this year, you will have to recognize the gain on the sale of the old tractor and will put the new tractor on deprecation at full value. This won’t really make a huge difference on your tax return with the increased amounts of bonus and Section 179, but for Nebraskans, this will be a large impact to your Personal Property Tax Return. Expect that bill to increase, starting with your 2019 return. (For more detailed information on this topic, see Elimination of 1031 Exchanges for Personal Property.)
The 2017 Tax Relieve Act contains many changes and it’s hard to try and quantify the effect on farms in general. It will take a personalized approach to see if this is a win for you. In general, this seems to be a good thing for farmers. The biggest downside is the return of the “sunset” and being back to the need to wait on extender bills.