The Tax Cuts and Jobs Act made significant changes to individual and corporate taxation by generally lowering tax rates and widening tax brackets. In addition, certain deductions were curtailed. There are several provisions that impact those in production agriculture. What follows is a summary of the significant items that farmers should be most aware of (all which take effect in 2018 unless otherwise noted).
Farmer Sales to a Cooperative – Section 199A
This issue has received much attention in the national news and relates to the new Section 199A pass-through deduction that is available to all non-C corporation taxpayers. Basically, a farmer (non-C corporation) would be eligible for a deduction up to 20 percent of gross sales to a cooperative. This could effectively zero out taxable income for most farmers. Using a $3.50 corn price, the deduction could be worth 70 cents a bushel. At 200-bushel corn, that is an extra $140 deduction per acre without needing to spend any cash. The bottom-line cash impact (dollars in your pocket) of the extra deduction depends on many factors, including your tax bracket, itemized deductions and whether you have off-farm income or not.
However, if a farmer sells to a private grain elevator, the deduction would only be 20 percent of net income (gross revenues minus expenses). Consequently, elevators that are not cooperatives would be at a competitive disadvantage—and it now seems clear this was an unintended consequence of the law. What remains unclear is how soon this provision will get fixed, and more importantly, exactly what the fix will be. Update: The 199A issue has been changed with legislation passed March 23, 2018.
Businesses can take 100% bonus depreciation (immediate write-off) on qualified property acquired and placed in service after September 27, 2017. Previously, such property was eligible for 50% bonus depreciation. This remains in effect through 2022, after which the percentage is scaled down to 80 percent (in 2023), 60 percent (2024), 40 percent (2025) and 20 percent (2026). Qualified property for bonus depreciation now includes used assets and generally applies to property with a depreciable life of 20 years or less. This is a significant change, as previously only new assets qualified.
Section 179 Expense
The maximum deduction under the Section 179 provisions is $1,000,000 starting in 2018—an increase from $510,000 in 2017. The starting point for the phaseout threshold (maximum property that can be placed in service) was increased from $2,070,000 to $2,500,000.
Improvements to non-residential real property such as roofs, heating, ventilation, air conditioning, fire alarm and security systems are also eligible (must be placed in service after the date the building was placed in service).
Tax Life and Method Changes
For assets placed in service in 2018, the Act shortens the recovery period from seven years to five years for most equipment used in a farming business. This excludes items such as grain bins, fences and land improvements. In addition, depreciation is computed using the “200% method,” which results in a faster write-off as compared to the “150% method.” This puts farming on par with other businesses that have been able to use the “200% method” for years.
Standard Deduction & Charitable Contribution Considerations
The standard deduction for a married taxpayer was increased to $24,000, which means even fewer taxpayers will be itemizing. There are two existing techniques farmers should be aware of relating to charitable contributions. First, farmers have an even greater reason to donate unsold grain to a charity, as opposed to donating cash. By donating the unsold grain, the grain sales never flow through reported farm net income; this ensures the farmer will get to deduct the donation (by not reporting the gross income). In addition, for self-employed farmers, the grain donated to charity escapes self-employment tax.
Second, those farmers who are over age 70, not expected to itemize, and required to take minimum IRA distributions should directly contribute a portion of their minimum distribution to the charity.
Both techniques have the added benefit of keeping Adjusted Gross Income (AGI) low, which factors into the Medicare premium surcharge, which otherwise can increase your Part B and Part D monthly premiums. Also, you may pay less income tax on your social security income by using these strategies.
State and Local Income Taxes
As you may be aware, individual state and local property, income and sales tax are deductible only up to $10,000 for 2018. For many farmers who do not itemize, this may not matter. Property taxes that relate to a business endeavor (farming or the rental of property) remain deductible. Therefore, only the property taxes on a personal residence (first and second home) are subject to the $10,000 cap.
Like-Kind Exchanges for Personal Property
While the Act kept like-kind exchange for real estate (Section 1031 exchanges), it eliminated the ability to defer the gain on an exchange of personal property (farm equipment). This means that the trade in allowance will be considered cash sale proceeds, and gain will be recognized for the amount that this exceeds basis. This gain is generally reported on Form 4797 and is not subject to self-employment taxes.
Because of recognizing the gain, the entire cost of the equipment being acquired will be eligible for depreciation. Therefore, given the new depreciation provisions, many times the overall transaction can still result in a wash for tax purposes. Gain on sale of item traded off can be completely offset by first-year depreciation on acquired item. This issue is something to watch for those S corporations that are still within the five-year built-in gains recognition period (corporation that elected S status on January 1, 2014, or later). For those S corporations, trading equipment will trigger the federal built-in gain tax, where previously the built-in gain tax could be deferred.
Estate and Gift Tax
The estate tax exemption amount was doubled to $11.2 million for an individual and $22.4 million for a couple. The increase is valid through 2025 and includes inflation adjustments. Note: if this provision is not extended, in 2026, the individual federal estate tax exemption would be approximately $6.9 million (assumes 2.5% annual increase). Keep in mind that the Illinois estate tax exemption remains at $4 million for individuals and does not get adjusted for inflation each year. Step-up in basis at death remains under both federal and Illinois law.
Overall, there are several favorable tax provisions to farmers in the law signed last December. The major uncertainty surrounds the Section 199A sales to cooperative provision and exactly how this will get fixed. Be sure to keep in touch with your tax advisor to stay up to date on this matter. iBi