Trade-Ins and Self-Employment Tax
Many farmers strive to report a certain amount of net farm earnings in order to increase their social security benefits at retirement. The 2018 wage base is $128,700 and it will rise to $132,900 for 2019. For earnings up to this level, self-employed farmers will pay 12.4% in self-employment (SE) tax which will show up as earnings when calculating their final social security retirement benefits.
However, the new tax law may prevent many farmers from showing any self-employment earnings if they trade farm equipment during the year. For example, assume a farmer normally reports $100,000 of net farm income each year. During 2018, the farmer trades-in a piece of fully depreciated equipment worth $150,000 on a new piece of equipment. This will result in reporting an $150,000 gain on form 4797 not subject to SE tax and showing a $50,000 farm loss to get income to $100,000. Even though the farmer reported net farm income of $100,000, there will be no SE tax owed and no build-up in the farmers social security earnings.
Now, there are a couple of ways to mitigate this. First, the farmer can always elect the optional SE method. Even though the farmer showed a loss of $50,000 on his Schedule F, the optional SE method allows the farmer to “report” $5,280 of SE income. This will result in additional SE tax of about $808, but allows the farmer to at least show this amount of income for social security retirement purposes. Secondly, in many cases, the farmer may need earned income in order to take advantage of the earned income tax credit or child tax credits. By electing the optional method, this will create at least $5,280 of “earned income”.
Another option for those states that do not require sales tax on farm equipment is to transfer all of the farm equipment into an S corporation and have all of the trade-ins incur inside of the corporation. In this case, both the gain from trading in equipment and the resulting 100% bonus depreciation on the new equipment is all reported inside of the corporation and will not affect social security earnings. Additionally, the farmer can then take a wage for properly managing the operations of the corporation thus building up their social security retirement benefits. This can also provide additional legal protection in case of equipment accidents. However, it does require more administrative efforts such as filing an additional tax return; one more payroll to perform, etc.
Most farmers strive to reduce SE tax, but many more want to maintain a certain level. With tax reform, farmers who trade equipment will find this harder to do.
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 principal with CliftonLarsonAllen in Walla Walla, 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. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
I would guess that the farmer would then lease the equipment from the LLC or Sub-S, whichever entity they would decide to form? Of course they would pay a fair rental which would be deductible on their schedule F. Just want to make sure I am understanding everything I need to in order to explain it to a few of my clients.