SE Tax Winners and Losers

We know that current Tax Act will change and it may not even happen.  However, I am going to show some examples of how self-employment (SE) tax will affect many farm situations.  For purpose of these examples, I am ignoring the effect of an increase or decrease to the 1/2 SE deduction on page one of Form 1040.  I am simply showing the net SE tax differences between current law and the proposed Tax Act as currently written.

Example – Schedule F Farmer

Ben is a schedule F farmer with $100,000 of normal farm income each year.  Under current law, he pays about $15,300 of SE tax.  Under the new law, he would only pay SE tax on a maximum of 70% of this income or $10,710.  He would save about $4,600.  Additionally, if he has purchased a fair amount of new equipment and has at least $1.2 million of “adjusted basis” in his farm assets, then none of his income would be subject to SE tax, thus saving $15,300 each year.  This assumes that the deemed rate of return is at least 8% (Fixed 7% per code plus short-term AFR).  We are not sure if adjusted basis includes regular depreciation (we assume it does).  We know it does not include Section 179 or bonus depreciation.  This means we will have another set of depreciation schedules to keep track of.

Example – Passive Investor in  a Farm Operation

Let’s assume that Ben is a limited partner in a farm partnership that generates the same $100,000 of net income.  He is not actively involved in the operation.  Under current law, none of the income is subject to SE tax.  Under the new proposal, it is likely that Ben will owe $15,300 of SE tax (at least based on our and other interpretation of the Act).  Additionally, there is some guidance that Ben would also face the Net Investment Income Tax on this income if he is over the threshold.  In that case, he would owe an extra 3.8% or $3,800 (which he would owe under current law anyway).  There is a current provision that states income subject to SE tax is not subject to the NIT tax.  However, we have read that the writers of the Act purposely subjected this type income to both SE tax and the NIT tax.  We shall see on this.

Example – Schedule F Farmer with Self-Rental

Let’s assume that Ben is still a Schedule F farmer, but instead of reporting $100,000 of Schedule F income, he reports $30,000 and pays cash rent to an LLC owned by him and his wife of $70,000.  Under current law, he pays about $4,500 on his Schedule F income but does not pay any SE tax on his cash rent income.  Under the new Act, his SE income on his Schedule F is reduced to about $3,150; but he will owe about $10,500 on his cash rent income.  This results in a net SE tax increase of about $9,150.

Example – Cash Rent or Crop Share Landlord

Let’s assume Ben is a cash rent or crop share landlord earning a net of $100,000 per year.  Under current law, none of this income is subject to SE tax.  Under the new Tax Act, it appears that all of this income may be subject to SE tax or $15,300 of additional SE taxes.

Example – S Corporation Farmer

Let’s assume Ben farms as an S corporation.  He pays himself a salary of $30,000 per year and the S corporation has ordinary farm income of $70,000.  Under current law, his net SE (payroll) tax is about $4,500.  Under the new Act, we take the net S corporation income of $70,000, add back the salary paid of $30,000.  This equals $100,000.  70% of this income is subject to SE tax less the $30,000 already paid to Ben.  This results in additional SE tax of about $6,120 (($70,000-$$30,000)X15.3%).

Example – S Corporation Farmer with Commodity Wages

Let’s assume the same example as the last one, but Ben pays himself a commodity wage.  Under current law, no SE tax is owed.  With the new Act, it is assumed these wages will be treated the same as in the Domestic Production Activities Deduction rules and will not be allowed as an offset against the 70% calculation.  Therefore, Ben will owe SE (payroll) taxes on $70,000 of income or about $10,700.

Example – C Corporate Farmer

Same Facts as the S corporation.  Under current law and proposed Tax Act, there would be no change to the SE (payroll) taxes owed.  There is no separate calculation of the 70/30 on a C corporation.  However, under current law, the corporation would pay a 15% tax rate on the first $50,000 of corporation income.  Under the new Act, this increases to a flat 20% tax.  Therefore on the first $50,000 of income, the corporation would owe an extra $2,500 of income tax.  But on the net $20,000 of income, the corporation would owe 20% instead of 25% for a net reduction of $1,000.  The net total increase in tax would be $1,500.  Remember that if the corporation paid cash rent income to Ben or to LLC/Partnerships owned by Ben, this income would be subject to SE tax.

Example – C Corporation Farmer with Tax-Free Housing

Many of our C Corporation Farmers also provide a tax-free fringe benefit to their owners in the form of housing.  100% of this housing is deductible by the corporation and non-taxable to the owner.  Under the proposed Act, this housing would continue to be deductible, however, all of the value of the housing would be additional compensation to the owners (we assume it would be included as compensation with a reduction in the housing costs).  Let’s assume that Ben’s corporation provides a nice house with a value of $35,000.  This would result in additional SE tax of about $5,400 plus he would owe additional personal income tax of about $8,750 (if in a 25% tax bracket).

I could provide many more examples, but I believe that these examples cover many of our farm operations.  The bottom line is about the only winner in the new Tax Act is the Schedule F farmer who has never set up an entity for cash rent of their farmland.  Almost every other farm situation will see a SE tax increase and it can be material.

We will keep you posted.

  • 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 partner 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 combine each summer for his cousins and that is what he considers a vacation.

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Comments

Thank you Paul for your time invested in playing out the various scenarios for us. It really helps.

It appears that for S-corp farmers who pay themselves a wage that the 70% of ALL the net profit is subjected to SE. I guess you can’t believe what you read in the papers that this is good news for pass-through entities. NOT! What happened to reducing the tax for pass-through entities of which as S- corp is one so is LLCs. You have to add that 15.3% increase to whatever the tax bracket you land in and that seems to be an increase rather than the advertised decrease.

It appears no matter your structure other than C corp that most (ahem, 70%) of the income will be subjected to SE taxes. Further, this was supposed to be moving toward simplification;it sure looks like a new kind of murky.

What am I missing here or is there no one in Congress who has ever signed the front of a paycheck????

If it does get passed, those bums in DC are probably going to wait until some time in 2018 to pass it so no one can use the 2017 tax planning to save some SE tax from 2018.

This will have a negative impact on those taking early social security with the expansion of income subject to self employment. It appears many would be caught surprised by the need to payback social security benefits as this could push them over the earnings limit.

Does any of this effect the maximum amount that is subject to SE Tax. What will be the maximum amount of income subject to SE Tax.

Thank you. Politics aside, what has become of “largest tax cut in American history”? What was once a huuuuge tax cut ends up “not so nice”. A shell game by politicians that CANNOT stop spending. Wow, that’s an idea. Cheers! Can’t wait for the final version…NOT. Just leave us alone already.

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