What the American Taxpayer Relief Act Means for Your Ag Operation
January 11, 2012
Market Journal host Jeff Wilkerson talks with Tina Barrett, manager of Nebraska Farm Business, Inc., about tax law changes that will affect Nebraska ag operations. Barrett is the author of this week's CropWatch stories on tax changes in ag. (This is the first of three Market Journal programs on this topic.)
January 1 brought a little snow, a lot of football games on TV, and a significant change in federal tax law as Congress finally reached a deal to avoid the “Fiscal Cliff.” There was so much talk about the tax rates that many people didn’t know what else the bill would change. By the time we finished reading the Act, there were many surprises. The following article addresses those provisions that apply most directly to agricultural producers’ tax returns.
- Depreciation (179 and Bonus)
- Income Tax, Capital Gains Tax, and Additional Medicare Tax Rates
- Alternative Minimum Tax
- Estate Tax
- Non-business Energy Credit, S-Corp Recognition Period, American Opportunity Credit; Tax-Free Distributions from IRA to Charities
Also, it may be somewhat comforting to note that many of the tax law provisions are "permanent." In the past few years many tax laws expired or were near expiration, forcing us to the “fiscal cliff.” Making these tax laws permanent means they will not simply expire but will require Congressional action to change them. This means they are less likely to be adjusted than if they were tied to an expiration date.
For the past several years we’ve been dealing with two types of accelerated depreciation methods: Section 179 and Bonus Depreciation.
Section 179 allows for a first year write-off of capital purchases up to an annual limit. Most assets purchased in a farming business that have a life class of less than 20 years, whether they were new or used when purchased, will qualify for Section 179. You can choose any dollar amount, up to the annual purchase limit or the amount of earned income on your tax return.
If your qualified purchases for the year exceed the annual purchase limit, your annual expense limit is reduced $1 for every $1 spent until it is used up. For example, if the annual expense limit is $500,000 and the annual purchase limit is $2,000,000 and you purchase $2,200,000 of qualifying assets, your annual expense limit is reduced to $300,000 ($500,000 - $200,000). If you exceed $2,500,000, your annual expense limit is reduced to zero.
Fall tax planning in 2012 was challenged by a significantly lower planned limit of Section 179. The limit was going to be $139,000 with the amount dropping significantly again in 2013. This was a major change from the amount we were used to spending in previous years. Instead, the American Taxpayer Relief Act of 2012 extended the amounts from 2010 and 2011 to 2012 and 2013.
By making this law retroactive to include all 2012 tax returns, the tax planning we did prior to the law is now decidedly different for many producers who purchased a large amount of equipment in 2012. There are some options that can still be changed to take advantage of the larger Section 179 limit. Some producers may elect to just reduce their income further by taking the additional expense. Others may want to consider electing out of installment sale grain contracts to recognize additional income in 2012 to offset the extra expense. These contracts must be for grain delivered in 2012 for which the sale income was deferred until 2013. Be sure to check with your tax advisor to see if this option is available to you.
Bonus depreciation has been in and out of the tax law since 2001. It began at 30% and has been as much as 50% or even 100%. The 50% bonus depreciation level available for 2012 was set to expire but has been extended at the same level for 2013.
Bonus depreciation is available for brand new assets only (you must have first use of the asset) with life classes of 20 years or less. This means most farm assets that are brand new will qualify. This is a significant difference from the less-than-20-years qualification for Section 179. Farm buildings have a 20-year life class. This means that while a machine shed or any multi-purpose agricultural structure will qualify for bonus depreciation, it is not eligible for Section 179. Many producers have taken advantage of this in the past several years, but the extension into 2013 gives those who haven’t, one more opportunity to build before the end of the 2013.
One other significant difference between Section 179 and Bonus Depreciation is for fiscal year taxpayers. Section 179 follows your fiscal year while Bonus Depreciation follows the calendar year. So if you have a fiscal year that starts April 1, 2013 and end March 31, 2014, you will have $500,000 of Section 179 to use for your 2013 tax return and a 50% bonus depreciation for only those assets that are purchased before December 31, 2013.
If both Section 179 and the Bonus Depreciation are used on the same asset, Section 179 must be applied first and then the bonus percentage can be applied. Thus, a qualified asset with a $600,000 cost basis would only be allowed a total expense of $550,000 ($500,000 under Section 179 and 50% of the remaining $100,000 as Bonus Depreciation).
Debate over the proposed income tax rates consumed much of the press coverage as well as bringing some complications with compromise. For anyone whose taxable income is less than $450,000 (married filing jointly) or $400,000 (single), the tax rates remain. (These are the "Bush Tax Cuts" that were put in place over 10 years ago.) If your income is over the designated amount, your highest tax rate will be 39.6%. What was not expected is that they made these tax rates permanent rather than setting an expiration date for a few years down the road. This is significant since it should avoid a future last minute, “fiscal cliff.”
The law also permanently extended the current capital gains tax rates while raising the rate for those over the $450,000/$400,000 level. If your total income falls in the 10% or 15% income tax bracket, your capital gains will be 0%. If you taxable income is over the 15% bracket, but under the $450,000/$400,000 level, you will pay 15% capital gains. If you are over the $450,000/$400,000 level, you will pay a maximum of 20% capital gains.
The law also made permanent that qualified dividends (like those paid from family corporations) will be taxed at capital gains rates.
The tax rates are complicated by measures in the healthcare bill that also will be taking effect in 2013. Part of that legislation called for an additional Medicare tax on individuals whose income was greater than $250,000. The additional tax is 3.8% on unearned income (rental, interest, dividends, etc.) and 0.9% on earned income (wages, farm income, etc.).
The following chart is an attempt to summarize all three tax rate schedules and how they fit together. Remember that while the capital gains tax replaces the income tax rate for qualified income, the Medicare Tax (both earned and unearned) is an additional tax on top of the income or capital gains tax.
|Table 2. Estimated 2013 taxes for married filing joint returns|
|$0 to $17,900||10%||0%||0%||0%|
|$17,901 to $72,500||15%||0%||0%||0%|
|$72,501 to $146,400||25%||15%||0%||0%|
|$146,401 to $223,050||28%||15%||0%||0%|
|$223,051 to $398,350||33%||15%||3.8%*||0.9%*|
|$398,351 to $450,000||35%||15%||3.8%||0.9%|
|$450,000 and up||39.6%||20%||3.8%||0.9%|
|*Starting at incomes of $250,000.|
The alternative minimum tax was enacted in 1969 to keep wealthy taxpayers from using legal deductions to avoid paying income taxes. When it was put in place, it affected 155 taxpayers. What they failed to do at the time was index the exemption for inflation. In time, inflation caught up with the exemption and Congress got into the habit of passing a two-year “patch” to fix the problem for the middle class. The last patch expired at the end of 2011 so we were due for another patch to avoid a significant tax of most taxpayers making over $50,000 a year.
The American Taxpayer Relief Act of 2012 permanently fixed the Alternative Minimum Tax retroactively to January 1, 2012 and indexed the exemption for inflation.
The federal estate tax has been widely discussed in the agricultural community for the past five years. Debate over repeal of the estate tax versus higher exclusions has finally been solved with the American Taxpayer Relief Act of 2012.
When discussing the Federal Estate tax, a few definitions are important to know.
Estate Tax Exclusion: Annual limit of net assets (in general terms assets at fair market value minus liabilities) that can pass through an estate tax free.
Estate Tax Rate: The percentage of tax you will pay on net assets that exceed the annual tax exclusion.
The American Taxpayer Relief Act of 2012 put a $5 million exclusion in place that is indexed for inflation with no expiration date. This is another pleasant surprise that comes out of the tax bill. A permanent exclusion provides an opportunity to do good long-term estate planning. With the rapid increase in the value of farmland, more and more producers need quality estate planning. Of course it’s possible that Congress will revisit this issue in the future.
If you have a net worth of more than $5 million ($10 million per couple), it is a good time to find a good accountant and attorney to start working on a reasonable plan to reduce the value of your estate. If you’re married and your net worth is more than $5 million, you may consider some simple planning to make sure asset ownership is divided evenly between spouses. Anyone, regardless of net worth, should periodically review their wills and other estate planning devices to make sure provisions are up to date.
The Portability Provision, new in 2010, also was made permanent with this law. This provision allows a spouse who doesn’t use the entire exclusion to “give” the remainder to his or her spouse. In other words, if the first to die has net assets of $2 million, an election can be made on the estate tax return that the remaining $3 million can be added to the surviving spouse’s exclusion. So when the second to die passes away, his or her exclusion would be $8 million.
This is a great tool, but it doesn’t take away the need to make sure the assets are split as evenly as possible. Some simple planning can make sure the marital exclusion can be used to its fullest potential and ensures that little to no exclusion is lost. It also would be beneficial in a situation where asset values are low when the first spouse dies and there is a rapid increase in valves before the second spouse dies. The election does have to be made on a timely filing of the estate’s tax return and you are limited to the portability from your last spouse. (You can’t stockpile portability from multiple spouses.)
Some smaller items in the tax act that pertain to farming operations include:
Non-Business Energy Credit
The non-business energy credit was put back in place for 2012 and 2013. This allows a credit for replacing windows, doors, etc with higher efficiency models. There remains a lifetime maximum credit of $500. In most cases, dealers of these items will know which items qualify for the credit. This had been set to expire in 2011.
S-Corp Recognition Period
It doesn’t affect many individuals, but the reduction of the look-back period is important to whom it does apply. If you have an s-corporation that was previously a c-corporation, there has been a 10-year waiting period before you can sell the assets that were in the c-corporation without paying the “BIG tax.”
The American Taxpayer Relief Act of 2012 reduces that window to five years for assets sold in 2012 and 2013. That means it affect s-corporations that were converted from c-corporations prior to 2008. At this time, conversions in 2012 or 2013 are still subject to the 10-year waiting period.
American Opportunity Credit
The American Opportunity Credit has been extended through 2017. The credit is a maximum of $2,500 for qualified tuition and fees, books, supplies and equipment. Up to 40% of it may be refundable if there is not a large enough income tax liability to offset.
This credit covers the first four years of undergraduate work for a student who is enrolled at least half-time in a degree program. The credit may be claimed by whoever claims the student’s dependency. In other words, if the student is a dependent on the parent’s return, the parents get the credit regardless of who pays the expenses for school. This has usually been the best education credit to claim although others are still available.
This bill also extended the above-the-line deduction for tuition and fees. This option may be a better choice for some taxpayers.
Manager, Nebraska Farm Business, Inc.