On Dec. 22, President Donald Trump signed HR 1 into law. This new law implements the most significant changes to our tax code in more than 30 years. This article provides a general overview of some of the provisions that most impact farmers.
• Tax Bracket Changes: Most farm businesses are taxed as sole proprietorships, partnerships or S corporations. This means business income is passed through to the owners, who pay taxes based upon individual income tax rates. HR 1 lowers individual income tax rates across the board, starting in 2018. The total number of brackets remains at seven, but the top rate will fall from 39.6% to 37%, and the amount of income covered by the lower brackets has been adjusted upward. The new law leaves the maximum rates on net capital gains and qualified dividends unchanged.
• Standard deductions: HR 1 increases the standard deduction from $12,000 to $24,000 for married filing jointly taxpayers and from $6,500 to $12,000 for single taxpayers.
• Eliminating the personal exemption: In conjunction with increasing the standard deduction and lowering individual income tax rates, HR 1 eliminates the personal exemption from 2018 through 2025.
• Elimination of various deductions: For State and local tax deduction, the new law limits the amount of combined state and local income and property taxes taxpayers can claim as an itemized deduction to $10,000. Property taxes incurred in a trade or business, however, continue to be fully deductible on a Schedule C, Schedule E or Schedule F.
For charitable contributions, the new law basically does not change the current law regarding deductibility of charitable contributions; however, with the increase in the standard deduction and the loss of many itemized deductions, many charitable contributions may no longer result in a tax deduction.
• Alternative minimum tax: The AMT still remains for individuals, but exemptions amounts are significantly increased.
• Child tax credit and new dependent credit: The child tax credit was raised from $1,000 to $2,000 per qualifying child. It also provides a $500 credit for dependents who do not qualify for the child tax credit, including those over the age of 16.
• Section 179 Expense: Beginning in 2018, Section 179 is expanded to provide an immediate $1 million deduction (up from $510,000 in 2017) with a $2.5 million phase-out threshold (up from $2.03 million in 2017).
• Bonus Depreciation: The new law allows 100% bonus depreciation for five years for qualifying property acquired and placed into service on or after Sept. 27, 2017. The additional first-year depreciation percentage is then reduced, until fully eliminated in 2027. HR 1 applies bonus depreciation to used property, as well as new property, whereas under the old law the bonus depreciation was applicable to new property.
• Farm equipment depreciation: Beginning in 2018, farm equipment may be depreciated over a period of five years, instead of seven years.
• Like kind exchanges: The new law retains IRC §1031 like-kind exchange treatment for real property, but eliminates it for personal property, such as farm equipment or breeding livestock.
• Net operating losses: Beginning in 2018, HR 1 reduces the five-year carryback of net operating losses for a farming business to two years. It also limits the net operating loss deduction to 80% of taxable income for losses incurred after Dec. 31, 2017.
• Domestic production activities deduction: Starting in 2018, HR 1 eliminates the DPAD deduction, which has been frequently used by agricultural producers and cooperatives. Ag Cooperatives will have a new 20% deduction, but it will not pass through to farmers like the DPAD did.
• Corporate Tax Rates: The new tax law permanently lowers the maximum corporate tax rate from 35% to 21%, beginning in 2018. The law also transforms the corporate tax structure from a graduated system to a flat rate for all income. As such, some small C corporations who traditionally managed the income to the 15% brackets will see an increase in their corporate income tax rate from 15% to 21%.
• Non corporate taxpayers: These individuals can generally deduct 20% of “qualified business income,” defined as the net amount of income, gain, deduction and loss attributable to a domestic trade or business, from their taxable income. This includes net farm income reported on Schedule F, as well as net cash rental income reported on Schedule E. It also doesn’t include reasonable compensation received by an S corporation shareholder or guaranteed payments received by a partner in a partnership. For farmers filing individually and farmers with income under $315,000 (for married couples filing jointly), the reduction is 20%. Once you go over this income amount, the limitation begins on the deduction to 50% of wages paid by a farm operation or 25% of wages paid plus 2.5% of original cost of depreciable farm assets that are less than 10 years old. This computation is not as easy as it sounds and separate depreciation schedules will need to be kept for this computation.
• Estate and Gift Returns: The new law doubles the basic exclusion amount for tax years 2018 through 2025. Thus, a person can die with $11.2 million of property in 2018 and the estate will owe no tax. Basis adjustments (often a “step up”) continue at death for all estates.
A majority of farmers are sole proprietors or structured as pass-through entities. If you are in this group, you should see some benefits from the deduction for business and pass-through income, immediate expensing of capital purchases, and potentially from reductions in individual rates.
As farmers, you should work with your tax advisers to see if you should make changes to your business structures or operations in response to the new law. Taxation is highly dependent upon your individual set of facts. In general, however, most agricultural folks should see lower tax liability for the next eight years because of HR 1. After that, however, the changes sunset at the end of 2025, meaning they go away, unless a future Congress acts to restore them.
Brian E. Ravencraft, CPA, CGMA is a Principal with Holbrook & Manter, CPAs. Brian has been with Holbrook & Manter since 1995, primarily focusing on the areas of Tax Consulting and Management Advisory Services within several firm service areas, focusing on agri-business and closely held businesses and their owners. Holbrook & Manter is a professional services firm founded in 1919 and we are unique in that we offer the resources of a large firm without compromising the focused and responsive personal attention that each client deserves. You can reach Brian through www.HolbrookManter.com or at BRavencraft@HolbrookManter.com.