More Guidance on Possible Tax Changes

• September 13, 2021
• Paul Neiffer

The House Ways and Means Committee released their Section-by-Section document titled “Responsibly Funding our Priorities” on how to pay for any new legislation.  This 18 page document outlines all of their projected tax changes and it is better to start out with what is not in the document:

• No changes to step-up in basis.  If their plan goes through as is, there will be no transfer tax on appreciated assets at death or during lifetime.
• No additional self-employment tax on earnings over $400,000 as outlined in President Biden’s green book.
• No changes to Section 1031 exchanges.

Now for what is in the document:

• A top corporate tax rate of 26.5%.  However, the first $400,000 of corporate taxable income will be at 18%, the next $4.6 million will remain at 21%.  For most, farmers this is actually a 14.28% reduction in tax since most farm corporate income will now be taxed at 18% instead of 21%.
• Top individual tax rate of 39.6% beginning at $450,000 for married couples and $400,000 for singles.  This is up from the current 37% top rate and will kick in much sooner.
• There will also be an extra 3% surtax if your taxable income is over $5 million.  This will not affect many farmers.
• Finally, on ordinary tax rates; if your taxable income is over $400,000 (single) or $500,000 (married couples), then the extra 3.8% net investment income tax will apply on all of your farm income over those hurdles (the first $400/500,000 is exempt).
• The top capital gains rate will be 25% instead of 20%.  However, you will also owe the 3.8% net investment income tax, therefore, the reality is a top rate of 28.8%.  There is a transition rule for gains reported in 2021 before the enactment.  Those will still get the old 20% top rate.
• The 20% Section 199A qualified business income deduction will be limited to $400,000 for singles and $500,000 for married couples.  Trusts and estates will be limited to $10,000.  We are not sure if this is on both the 199A(a) 20% deduction and the 199A(g) DPAD deduction.  If it applies to both, this may sharply curtail the ability to fully deduct DPAD for many farmers, especially dairies and orchardists.
• The current limitation on excess business losses will be made permanent.  This only allows up to $500,000 of business losses (indexed to inflation) to offset wage or other income in any year.  The excess is carried forward as a net operating loss.
• The current lifetime estate tax exemption of $10 million indexed (currently $11.7 million) will revert four years early.  Instead of it reverting to $5 million (indexed to inflation) in 2026, it will revert in 2022.  The top estate tax rate of 40% will remain.
• Farmers will get a greatly enhanced Section 2032A estate tax deduction.  Under current rules, you can reduce a taxable estate by about $1.2 million for farmland.  This will now get increased to $11.7 million (assuming it is indexed but not sure).  This means a farm couple could easily be worth up to $35 million and the heirs would owe no estate tax.  The drawback is that heirs would lose the step-up on any assets subject to the Section 2032A reduction and the definition of a family farm is fairly restrictive.  It must be actively farmed by the family for 10 years and if you blow it in year 10, you owe the tax plus interest and you only get a step-up for the estate tax paid.
• Certain grantor trusts such as intentionally defective grantor trusts (IDGTs) or spousal lifetime access trusts (SLATs) will lose their favorable tax status.  Any sale to these trusts would become taxable unlike current rules.
• Finally, some discounts on transfers of nonbusiness assets will be eliminated.  However, it is difficult to determine if this applies to transfer of farms or farmland held in LLCs or corporations.

All-in-all, compared to the imposition of a transfer tax, the limitations on Section 1031s and the self-employment tax law changes, this current proposal may not be too bad for most farmers and in some cases farmers may actually see lower taxes.

However, this is only the proposal from the House.  We still need to see the Senate proposal and it may bring back some of items we would prefer not to see.  But it appears the transfer tax is dead, at least for now.

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