As tax reform bills move through both houses of Congress, farmers and ranchers would be wise to pay attention to proposals that could affect their tax obligations as early as next year.
That’s assuming that either a Republican House bill or a Republican Senate bill can garner enough votes from entrenched Democrats or even hardline budget hawks in their own party to get to a conference committee.
The House and Senate bills are “more similar than I expected,” says Tiffany Lashmet, Texas AgriLife Extension law specialist at Amarillo. But no one expects either to move through various committees without tweaks, at least, or possibly even major overhauls.
Tax reform, Lashmet says, “is a moving target and frequent changes make it difficult to determine how farmers and ranchers will be impacted. We can’t predict anything at this point,” she says. “The bills will change.”
Still, she advises farmers and ranchers to be alert to proposals that may reduce or add to tax burdens in 2018 or later. Some things may sound good but provide little benefit to most agricultural producers.
She points to proposed changes in the estate tax, a fundamental principle of Republican legislators for years. Both bills would double the exclusion amount allowed for each person. Both versions exclude up to $11.2 million in assets for any person who dies in 2018. Also, both bills retain portatility, which is the ability of a surviving spouse to transfer an unused portion of the deceased spouse’s exclusion amount. With the proposed $11.2 million per person exclusion, if both spouses died in 2018, the exclusion amount would be $22.4 million.
The House version repeals both the estate tax and the generation skipping tax, beginning in 2024.
The Senate proposal doubles the individual exclusion, but does not repeal the estate tax or the generation skipping tax for estates valued greater than the increased base exclusion.
That seems like a good deal for ag operators, Lashmet says, but the number of operators who will benefit is miniscule. “In 2002, the exemption was only $1 million,” she says. “It was pretty easy to get to that, and numerous farm families were impacted by the estate tax at that exclusion amount. It takes a lot more to get to $5 million, and at $11.2 million or $24 million for a couple, not many will be affected.”
A report from Kristine Tidgren, Iowa State University Center for Agricultural Law and Taxation, notes than in 2016 only 5,219 estate tax returns were filed in the country. Of that, only 682 taxable estates had any farm property (2 percent of total taxable assets).
Lashmet also notes that sound estate planning can avoid much of the estate tax burden for persons who may have estates valued above the exemption amount.
STEPPED UP BASIS
Of more concern, is the concept of stepped up basis. “A step up in basis remains in both versions,” Lashmet says. This is important for landowners who may eventually wish to sell their property and will ultimately face paying capital gains taxes. Without a step up in basis, a landowner would pay capital gains taxes on the difference between the initial purchase price of the property (the basis) and the sales price. With stepped up basis, the basis is allowed to change to the current value — most often to increase — when land is inherited at the death of a prior landowner.
“Given the tremendous increases in agricultural land values in the past few decades, this is important for ag producers,” says Lashmet.
Increasing the standard deduction also sounds good at first, but may not pencil out if typical deductions are lost. Lashmet says it needs to be analyzed to determine whether farmers and ranchers will still come out better by itemizing deductions, even with the increased standard deduction. “It’s a trade off, and producers need to look at the impact.”
Deductions on the chopping block in the House include property tax, state and local taxes, medical expenses, tax preparation fees, moving expenses (except for military) student loan interest, unreimbursed employee expenses, personal casualty losses and alimony.
The Senate retains personal casualty losses if the loss was due to natural disaster, which must be addressed by presidential disaster declaration. It also retains deductions for medical expenses that exceed 10 percent of adjusted gross income; it keeps deductions for alimony and student loan interest. The Senate plan completely eliminates deduction for property taxes.
The House plan retains charitable contributions, a deduction for property taxes (up to $10,000), and the home mortgage interest deduction for new mortgage debt, up to $500,000. Currently, that limit is $1.1 million.
The Iowa State report indicates that lowering tax rates for “pass-through businesses” may affect farms. The report says most small businesses, including farms, operate as sole proprietors, pass-thorough entities such as partnerships or S corporations. “Lowering the [corporate] tax rate would not aid them.”
Both the Senate and House proposals provide other ways to reduce taxes on these entities. But they also want to prevent abuses.
In the House, maximum tax rate for sole proprietors, S Corporations and partnership drops from 39.6 percent to 25 percent. Getting the reduction, however, is complicated, “to ensure that tax payers can’t shift wage income to business income to take advantage of the preferential rate,” the report states. “By default, 30 percent of a typical pass-through business’s income would be considered ‘qualified business income’ entitled to the lower rate. The other 70 percent would be considered attributable to labor and taxed at ordinary individual income tax rates. Passive business income would be wholly taxed at the lower maximum rate.”
Expensing offers something for ag producers to chew on as well. Lashmet says 1031 tax deferred exchanges remain the same for real property but does not include personal property, such as equipment and livestock. The 1031 allows a taxpayer to sell income, investment or business property and replace it with a like-kind property, and defer or postpone capital gains tax.
Not allowing like-kind swap of equipment could affect a farmer’s ability to replace aging machinery, she says.
Another proposal currently in the House bill that could have significant negative impact on agriculture has to do with considering revenue to landowners from cash leases as self-employment income, Lashmet says, but adds that House Agriculture Committee Chairman Mike Conaway has indicated he will get the self-employment tax language fixed so that leased land is not considered self-employment. Current language deems revenue from cash land leases as self-employment, which would be taxed. “That could be a big deal to farmers who lease acreage,” Lashmet says. Landowners could decide to increase land rents to cover the added tax or take the land out of production.
K-Coe Isom, a consulting and CPA firm in the food and agriculture industry, labels the House tax reform bill a “mixed bag,” lauding phase out of the estate tax and “for not limiting farmers’ ability to use the cash method of accounting.”
Other provisions cause concern, according to Jeff Wald, K-Coe Isom CEO, who says some provisions of the House bill could increase farm tax liabilities. Those provisions include restrictions in interest deduction, curtailment of carry-back of losses, elimination of the Domestic Production Activities Deduction, and limitations on the like-kind exchanges.
Wald says although the bill would reduce the top corporate tax rate to 20 percent, the individual rate into four brackets, create a new 25 percent tax rate for pass-through entities, double the standard deduction, provide for increased expensing of capital assets, and phase out the estate tax, it comes with caveats. “The bill would remove many deductions used by farmers and ranchers today.”
He offered four recommendations for Congress to consider to aid agriculture:
Exempt farm businesses from limits on interest deductions;
- Allow farmers and ranchers to use like-kind exchanges for farm equipment;
- Exempt agriculture from the elimination of the Domestic Production Activities Deduction (Sec 199); and
- Allow agriculture to carry-back losses to offset taxes paid in previous good years.
The National Council of Farmer Cooperatives (NCFC) weighed in on the Domestic Production Activities Deduction, which would affect cooperatives and their farmer-members.
In a press release, NCFC stated that more 180 agricultural organizations, cooperatives, and other agribusinesses sent a letter to House leadership expressing opposition to repeal of the Domestic Production Activities Deduction (Section 199).
“Ending the Section 199 deduction for agriculture would result in many farmers paying more in taxes, as most do not pay under the corporate code, and the current proposal will not overcome the loss of the deduction,” according to an NCFC spokesperson. “In many cases, farmers will see a double-digit increase in their tax bills under the proposed plan.”
Section 199 allows cooperatives to deduct proceeds earned from products manufactured, produced, grown, or extracted, and pass deductions directly back to farmer-members. “Support for Section 199 is critical for rural communities,” NCFC said.
Lashmet says nothing is simple about tax law, and that trying to discern exactly what will find its way into a final bill is impossible. She does recommend that farmers stay alert to legislative activities over the next few weeks and contact elected officials to express their concerns.
It’s also not too early to consult tax advisors and begin preparing not only for 2017 tax season but also to begin considering that proposals now under consideration could be in effect as early as 2018.