The Proposed “Tax Cuts and Jobs Act”

The House Ways and Means Committee finally released their 429 page “Tax Cuts and Jobs Act” this morning.  I have read through (not every word) the Act and I will attempt to give my feedback of what I know.  Part of this Act is extremely difficult to interpret so I may need to update my blog post later on if I am in error (This is your warning and this may be the longest post I have ever done).

Here are the major items applicable to farmers:

Tax Brackets

  • 12% tax bracket on income up to $90,000 (MFJ) and half that for singles
  • 25% tax bracket on income from $90,000 to $260,000 (MFJ) and $200,000 single (can we say marriage penalty)
  • 35% tax bracket on income from $260,000 to $1 million (MFJ) and $500,000 for singles
  • 39.6% on income over $1 million or $500,000. The 12% tax bracket is phased-out at levels slightly higher than this.

Capital Gains Tax Rates

  • 0% on gains in taxable income up to $77,200 (MFJ), singles up to $38,600
  • 15% from $77,200 to $479,000 (MFJ) and $425,800 (again a marriage penalty)
  • 20% on capital gains over these amounts

Child Tax Credit and Education Credits

  • Increased from $1,000 to $1,600
  • New $300 credit for other (parent’s and non-qualifying child, etc.)
  • American Opportunity Credit is now eligible for up to 5 years
  • Almost all of the other current education credits and deductions are eliminated.

Corporate Tax Rates

  • 20% on regular C corporations
  • 25% on personal service corporations

Flow-through Tax Rates (this is the most difficult and may change a lot)

  • A maximum tax rate of 25% will likely apply to :
    • All net passive income plus
    • All qualified business income
  • Qualified business income will be the greater of
    • 30% of active business income or
    • A deemed return on your business divided by your net income from the business
  • Let me try to give you an example on this that I think is correct:
    • A farmer has capital invested in his farm business of $2 million (based on depreciated values not including Section 179 and bonus depreciation).  His allowed deemed return is 7% plus the short-term AFR rate as of the end of the year.  Let’s assume this is 1%.  Therefore, the farmer is allowed to earn up to $160,000 on his farm.  If he earns this amount or less, then all of the income is allowed to be subject to the 25% tax rate.  At least, I think this is how it works.  I had to read it multiple times.  This will be extremely difficult to calculate.
  • It is tough for me to determine if cash rent and crop share income will qualify for the flow through rate.  This income is not passive (if positive) and it does not qualify as an active trade or business, therefore, it may be subject to the highest tax rate.

Self-employment tax on business, passive and rental income

  • Real estate rental income will be subject to self-employment tax.  It does not matter if it is crop share or cash rental income.
  • All limited partnership/passive ordinary income will be subject to self-employment tax (it may only have a 25% top income tax rate, but will have up to a 15.3% self-employment tax rate).
  • Active business income from flow-through entities (S corporations and partnerships) and active business income on Schedule C and F will be subject to self-employment income up to a maximum of 70% of the income.  It will be based on the percentage of income subject to the maximum tax rate.  In our example above if this was an S corporation, the first $160,000 of income is not subject to self-employment tax, the excess would be.

Warning – This is how I read the Act.  I may be wrong.  Also, this is a proposal and it may change dramatically next week and the Senate will have a say too.  However, our blog has been warning you that provisions similar to this were coming, so I will not be surprised if this become final (or even worse).

Individual Income Tax Provisions

  • Itemized deductions are only allowed for:
    • Property taxes up to $10,000
    • Mortgage Interest on loans up to $500,000 and only on one home.  No more second home interest deduction.
    • Charitable contributions (can offset up to 60% of income up from 50%).
  • Alimony income will not be taxable but no deduction for alimony paid
  • No moving deductions
  • The exemption of up to $500,000 for selling a personal residence requires living in it 5 of the last 8 years up from 2 of last 5.  Also, if the taxpayer has average income in excess of $500,000 (MFJ) or $250,000 for singles, the excess will reduce the amount of gain that can be deferred.
  • Can not reconvert a Roth back to a regular IRA
  • Alternative Minimum Tax is eliminated

Business Provisions

  • 100% bonus depreciation on new assets will be allowed until January 1, 2023.
  • Section 179 remains the same until 2023 when it jumps to $5 million and phase-out would begin at $20 million.
  • Small business (average revenues under $25 million) are:
    • Not subject to Section 263A (will allow you to deduct preproductive costs),
    • Allowed to deduct 100% of their business interest.
  • Domestic Production Activity Deduction (DPAD) is eliminated.  This has been a very good deduction for coops and dairies.
  • 1031 Exchanges will be allowed for real estate only.  However, with 100% bonus depreciation and increased Section 179 it may not matter on farm equipment and buildings.
  • Several credits such as Work Opportunity Credit, New Markets Credit and Rehab credit are eliminated.  Many of the energy credits remain.
  • Employer provided housing by a farm C corporation will now be included as income to the employee if it is for a more than 5% owner of the C corporation.  Other employees will only have it included if it exceeds $50,000.  This means that current employer provided housing to owners is still allowed, however it will become taxable to the owner.
  • Net operating losses can no longer be carried back (some special rules will apply), but can be carried forward indefinitely.  The amount carried forward will have an “inflation” adjustment of 4% plus the short-term AFR as of the end of the taxable year.
  • Net operating losses can only offset up to 90% of taxable income.

Estate and Gift Tax Provisions

  • Estate and Gift Tax Lifetime exemption is doubled to $11.2 million (2018)
  • Estate and Generation Skipping Tax is eliminated beginning in 2024
  • Gift tax will remain but with the higher exemption amount
  • No changes on allowed discounts for transfer of farm entities, etc.

The bottom line

For many of our farmers, it is likely that your overall income tax may go down, however, it is just as likely that your self-employment tax will increase and the increase may be more than your tax savings.  The increase in the estate tax exemption / elimination is very positive since there does not seem to be a reduction in step-up in basis.

This is the first “Act” in a play that will have multiple more “Act” and the “Play” may end with no change at all.  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

Contrary to Simplification the deemed rate of return methodology is fraught with confusion. So you have assets you’ve depreciated out. So how would that work? It just strikes me as punishing to pay SE tax on farm income that remains in the farm business for operating capital. This income is NOT distributed to the owners . We are already paying SE tax on wages and take no distributions. The net income is taxed now on our regular return. ( we are S-corp). It appears this is also contrary to lowering the brackets for small businesses regardless of whether you are a pass-through entity or sole prop. Thankfully they left the cash accounting option open. . . .

Will land owners have to pay social security on land rent regardless of age?

Warren, it is still too early to determine if landoweners will actually owe SE tax. However, if they do, it will not be dependent on age unless they do something similar like they did with CRP rents. We will keep you posted.

Thanks for the info. Is there a larger increase in the old standard deduction amounts, to offset some of the loss of exemptions?

Thanks for the early bird warnings. I look forward to more of your analysis as the changes solidify. Please keep the details coming!

Will real estate taxes on farm land be deductable?

Yes, real estate taxes on business property including farm land remains tax deductible. It is only personal property taxes that are capped at $10,000.

Paul-Can you refer me to the section of the bill that leads you to conclude that passive rental income will be subject to self-employment taxes?

Paul- thanks for taking the time to wade thru the 479 page bill, you must have been up all night. Great summary of the changes that could potentially impact our farm clients.

Will the personal exemption per person still remain or what that eliminated on the personal tax return?

Personal exemptions are gone. However, the child tax credit has been bumped to $1,600 and there is a new $300 credit for other exemptions including parents. This continues to be phased-out with higher income levels.

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