Key Aspects of House Tax Reform Proposal for Farmers

The House Republicans issued a proposal last week detailing their plans for tax reform (likely to occur in 2017).  The Tax Foundation has issued several articles on how this reform may affect business and individuals and I am going to recap what I see as the key aspects of their proposals.  Farmers must be aware of these items, but any actual tax reform is likely to be different and the differences can be material.

Key individual taxpayer items are as follows:

• Three tax rates (12, 25 and 33%).  The 12% replaces the current 10% and 15% bracket.  The 25% replaces the current 25% and 28% brackets and the 33% replaces the current 33%, 35% and 39.6% brackets.
• There would no longer be a “separate” tax bracket for long-term capital gains and qualified dividend income.  Rather, the taxpayer would be allowed to deduct 50% of this income (plus interest income); therefore, the net investment income tax rate would be 6%, 12.5% and 16.5%.  This is either an increase from the current tax rate (capital gains taxed at zero in the 10% and 15% tax bracket) or a decrease (top rate is currently 20% plus the 3.8% net investment income tax).
• Individuals will only be allowed to deduct home mortgage interest and charitable deductions; however, the standard deduction will about double for all taxpayers.  Some commentators have already noted that gambling losses will likely need to be addressed.  As currently proposed, all gambling income would be taxed and there would be NO deduction for any gambling losses.
• Eliminates the dreaded Alternative Minimum Tax (AMT).  Although this is long overdue, it is likely that the AMT would hardly apply to most taxpayers since state and local income, sales and real estate taxes are not allowed as a deduction along with miscellaneous deductions not being allowed.  I would guess most AMT is caused by a combination of these two items.
• There are various other changes to child credits, elimination of the personal exemption, etc. but the above items are the likely major individual changes.

The key farm business changes are as follows:

• The top C corporation tax rate will be 20% down from the current 35%.  All “business” income that flows through from partnerships and S corporations will be subject to a top tax rate of 25% (not sure about trusts that own farm operations).  This provision is likely to be “abused”.  Current high-income employees will go out of their way to create “business” income to reduce their tax rate from 33% to 25%.  Kansas has already seen how that has affected their tax base.
• Allows for full immediate deductibility of any capital purchase (not including land).  This would be like SUPER 179 since it would be unlimited and include all farm buildings.  This would be a major upgrade over current restrictions on deduction of capital investments.
• Eliminate the ability to deduct net business interest.  If you purchase land or equipment with debt, none of that interest expense paid will be allowed as a deduction.
• Net operating losses will no longer expire after 20 years, however, you will not be able to carry them back and you can only offset against 90% of your income in any year (similar to the current AMT NOL deduction rules).  Farmers can currently carry back their farm losses five years (or elect to carry back two years) and with the current loss situation that frees up working capital that would not be allowed under this proposal.
• Eliminates the Section 199 Domestic Production Activities Deduction.  The current deduction is about 9% of net farm income (however many farmers get little or no benefit since it is also limited to 50% of FICA wages paid).
• Eliminates the estate tax.  This would be good news for farmers, but under current law most farmers will not be hit with the estate tax and many farmers will still be subject to the estate tax in their state (Washington, Oregon, Minnesota and other states).

All-in-all, the proposal has many positive aspects, however; the rub will be in the actual law that gets passed.  Even though the Senate is currently held by the Republicans, their ideas are likely to be substantially different and the new President will weigh in on the matter too.  There is consensus on the need for reform, but no common ground on how to get there.  We will keep you posted.

Paul Neiffer, CPA

CliftonLarsonAllen, LLP