We Have a Tax Bill (Maybe)
Yesterday, the Tax Conference Committee finally released the final tax bill that will be voted on next week. It is my assumption that this bill will pass and be signed by President Trump sometime next week (otherwise they would not have released it). Therefore, I am going to provide in this blog the pertinent highlights for farmers. Future blog posts will dig into more of the details.
- There is a retention of 7 tax rates, ranging from 10% to a top rate of 37% (starts at $500,000 for singles and $600,000 for MFJ). Notice the marriage penalty here. Two singles can each make $500,000 and not pay the 37% tax rate, whereas, a married could would owe this rate on $400,000 of income. Although it is still lower than the current top 39.6% tax rate.
- Qualified farm income (to be determined if it includes self-rental income) will qualify for up to an extra 20% tax deduction. If your income is under $315,000 (for married couples), there is no limit on this deduction. You essentially take your net farm income, multiply it by 20% and this is your extra deduction. However, once you go over this amount, a limitation on this deduction begins. It is the greater of 50% of wages paid (grain wages and kid wages do not count) by the farm operation or 25% of wages paid plus 2.5% of original cost of depreciable farm assets that are less than 10 years old (it is a little more complicated than this to calculate). As an example, assume a farm earns $500,000, pays wages of $125,000 and has original asset cost of $2.5 million. The gross 20% deduction is $100,000. It is limited to the greater of (1) $62,500 ($125,000 X 50%) or $125,000 ($125,000 X 25% plus $2.5 million X 2.5%). Therefore, the farmer could deduct the full $100,000. This will require us to maintain a new depreciation schedule solely for calculating this deduction (there goes tax simplification).
- Corporations will now be taxed at a flat 21%. For many farmers, this is actually a 40% tax increase since many farmers currently only pay 15% on corporate income. Pass-through entities may still make more sense than corporations due to the following:
- With the 20% deduction for farm income, the top rate is 29.6% which is only 8.6% higher than corporate rates
- Unless you are in a 32% or higher tax bracket, net farm income will always be taxed lower than 21%
- The dividends from the corporation are still subject to a top tax rate of 23.8%
- Many flow-through entities will get a step-up in basis, whereas only corporate stock gets a step-up.
- The lifetime estate tax exemption is bumped temporarily to $10 million indexed to inflation ($11.2 million in 2018). This will revert back to current amounts in 2026. It retains the step-up in basis for inherited assets. This means that a married farm couple that passes away between now and 2026 could likely be worth $30 million and not owe any federal estate tax (taking advantage of appropriate entity discounts, etc.) However, you need to watch out for state estate taxes. This same couple worth $30 million might not owe federal estate tax, but could very easily owe $2-3 million in state estate tax.
- Section 179 is bumped to $1 million beginning in 2018 with a phase-out starting at $2.5 million.
- Bonus depreciation is increased to 100% for all new and used farm assets other than land. This is effective for assets placed in service after September 27, 2017. The only negative is that most states do not allow for bonus depreciation or increased Section 179 deductions. You are not allowed to take bonus depreciation or Section 179 on purchases from certain related parties, so care must be used in any family asset transactions going forward.
- Section 1031 tax-deferred exchanges are now only allowed for real property. Personal property exchanges will be taxed but not subject to self-employment tax. Also, to have an exchange, you must purchase replacement property which will be 100% deductible under bonus depreciation until 2023 and Section 179 may be available to soak up any balance. However, for farmers in states that do not provide for enhanced bonus depreciation or larger Section 179 deductions, you will face larger state income tax bills due to the elimination of Section 1031 exchanges on farm equipment (assuming the state follows federal law and eliminates personal property exchanges).
- The Domestic Production Activities deduction has been eliminated effective for taxable years beginning after January 1, 2018. The special 20% deduction outlined above essentially takes its place and farmers who sell their crops to a cooperative may receive a larger deduction (we are still going through the calculations on these transactions).
- The current 100% deduction for meals will drop to 50% and then be phased-out beginning in 2026. There are no changes regarding employer provided housing (as was contemplated in the House bill).
There are many more provisions in the next tax bill. However, this blog post is probably already too long and over the next few weeks we will provide more details. All-in-all, for most farmers I would give this tax bill a grade of B. It could have been better, but it is likely better than our current tax laws for most farmers.