Built-in Gain Tax May Apply More Often

Many farmers have converted from an C Corporation to an S Corporation in the last few years and I would expect several more conversions due to the new tax law.  However, as part of this conversion, there is a built-in gains (BIG) tax that is owed on the sale of any appreciated property that happens in the first five years.  After that period, the BIG tax normally does not apply.

Now that trades of farm equipment are no longer allowed under Section 1031, this may trigger BIG tax that a farmer is not aware of or planning for.  Under the old law, these trades did not trigger the BIG tax since there was no gain reported to the IRS.  Under the new law, this gain will be reported and subject to the BIG tax.  The good news is that the rate is 21%.  The bad news is the rate is 21%.  Also, many states will apply a BIG tax on income during these five years based on their corporate tax rate.

Example – Farmer Williams switched to an S Corporation effective January 1, 2018.  The only asset she had was a combine that was fully depreciated and worth $200,000.  She trades it for a new combine and gets a trade value of $200,000 which results in reporting a gain of $200,000 for the year.  On her tax return, she is required to pay a BIG tax of $42,000 and the flow-through income reported by her on her tax return is now only $158,000.  She is allowed to reduce the gain flowing through by the BIG tax paid.

However, the BIG tax is owed only to the extent of taxable income reported by the S corporation.  In our example, assume that she is able to get the income down to zero for 2018.  This would defer the BIG tax until 2019 and if she can keep income to zero for the whole five years, there is no BIG tax owed.

Remember, you only owe BIG tax if the S corporation reports positive taxable income.  With today’s crop prices, rents paid on ground owned and commodity wages, it is fairly easy to get taxable income to zero.  If you don’t, you may owe some BIG tax that you were not counting on.

  • Principal
  • CliftonLarsonAllen
  • Yakima, Washington
  • 509-823-2920

Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Yakima, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. In fact, Paul drives a combine each summer for his cousins and that is what he considers a vacation.

Comments

Has there been any discussion as to the state carryforwards of 179 and bonus deprecation if S-election is filed? For example, in MN, only $25k is allowed and 80% of the difference is added back to MN income in year 179 is used. Then 20% of that is subtracted for five following yeas. If a C-corp were to convert to S, with two or three year of subtraction carryforwards, would they be lost?

So is the BIG tax sort of suspended and if she would have income in any of the first five years as an S-corp, then that first year’s gain is captured? (Also thinking of zero basis grain sold in first year as S-corp.) Thanks.

That is a good way to look at it. You have to keep income at zero or lower for all five years. Otherwise the BIG recognized in year one gets paid in any year with net income.

Paul, have you addressed the involuntary conversion of personal property under the new tax bill? Farm equipment can be damaged/stolen and be covered by insurance. This could become a taxable event if like-kind exchanges of personal property are not allowed. Thank you.

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