As you’re preparing your 2017 tax information and meeting with your tax service provider over the next few months, it’s an opportune time to outline some of the new tax reform topics as they pertain to our farming and ranching communities for 2018 and beyond. The purpose of this article is to help you prepare questions and discussion topics to discuss with your tax advisor.
A lot of debate and fanfare led up to what is commonly referred to as the Tax Cuts and Jobs Act—and for good reason! Not one individual taxpayer or business won’t be affected by some part of the new law, either directly or indirectly. That being said, let’s focus on the changes that affect agricultural businesses.
Tax Rate Reductions
The most all-encompassing aspect of the new legislation is tax rate reductions. C corporations are going to enjoy a new flat tax rate of 21%. Agricultural businesses structured as flow-through entities (and which therefore report that income on their individual return) will see the current seven brackets of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% be replaced with 10%, 12%, 22%, 32%, 35%, and 37%. In addition, the taxable income ranges associated with each bracket were adjusted slightly, in most cases favoring the taxpayer.
The Artichoke – Section 199A
For those who enjoy the delicate flavor of an artichoke, you know it’s the heart that everyone is after. The sturdy leaves of the artichoke must be removed before you can get to the reward at its center. The domestic production activities deduction is gone, and another deduction is here in its place. Enter Section 199A, the deduction for Qualified Business Income (QBI). At its heart, this new code section allows a 20% deduction of QBI for owners of pass-through entities (S corporations, partnerships, Schedules C, E, and F) whose taxable incomes are below $315,000 for joint filers and $157,500 for single filers. Once these income levels are surpassed, the full picture of Section 199A—in all its artichoke glory–is revealed.
The Leaves Get in the Way
The bothersome leaves, or in this case, phaseouts, wage limits, and qualified property limits, make calculating this deduction difficult. Plenty of technical guidance from the IRS is expected throughout the year on this calculation alone. If you exceed the income limits and have always prepared your own tax returns, this may be the time to find a trusted tax advisor to ensure the calculation is done properly. At the very least, this is something you will want to monitor the application of very closely—so you can have your artichoke and eat it too!
The Artichoke and Cooperatives
Section 199A, as it is currently written, offers a benefit to farmers who sell their product to agricultural cooperatives. If farmers sell to cooperatives, they can deduct 20% of their gross sales. If they sell to other farmers or businesses, they are allowed a 20% deduction of net income.
For example, Farmer Greg sells $100,000 of grain to his local co-op and has $80,000 of expenses for the year. The way the law is currently written, Farmer Greg will have zero taxable net income ($100,000, less $80,000 in expenses, less 20% deduction of sales [$20,000] = $0).
Farmer Joe, on the other hand, sells $100,000 of grain to a neighboring farm. Farmer Joe also has $80,000 of expenses. Farmer Joe’s taxable net income will be $16,000 ($100,000, less $80,000 in expenses, less 20% deduction of net income [$4,000] = $16,000).
This unintentional discrepancy appears to have come about as a result of the rushed nature of getting the tax reform bill passed. Because of this, its authors, Senators Hoeven and Roberts, are working on a solution to attach must-pass legislation this year to correct it. So, before you decide to sell only to co-ops going forward, please stay up to date on this issue. As quickly as the benefit came about, it could disappear!
Many new depreciation changes are going into effect to help accelerate deductions. In summary:
- One hundred-percent bonus depreciation is back! This allows you to completely expense eligible fixed assets in the year of purchase. This is one of the few changes that became effective in 2017, September 28 to be precise. The requirement that the property had to be “new” and not “used” has been removed as well.
- Section 179 expensing has been increased to $1 million, with applicable phaseouts beginning after $2.5 million in fixed asset purchases for the year.
- The requirement for farmers to use the 150% declining-balance method for fixed assets used in farming is gone, and a new five-year recovery period for machinery and equipment used in farming has been created. This means higher depreciation deductions and shorter recovery periods.
- The Qualified Improvement Property category has a 15-year recovery period and combines the former Qualified Leasehold Improvement, Qualified Restaurant, and Qualified Retail categories.
- Farm buildings will continue to be depreciated over 20 years and qualify for 100% bonus depreciation.
Odds and Ends
Business interest expense – This may be limited if average gross receipts exceed $25 million.
Net operating losses (NOL) – While the rest of the country loses the ability to carry back NOLs, farm losses are excluded and still eligible to carry back two years and carry forward indefinitely. The NOL deductions will be limited to 80% of taxable income, however.
Like-kind exchanges (Section 1031) – Like-kind exchanges, allowing the deferral of taxable gain, will be allowed only for real property. This means any exchanges involving personal property, equipment, or breeding livestock will be required to recognize taxable gain in the year the exchange occurred. The newly acquired property will then be treated as a purchase, eligible to be depreciated.
Meals and Entertainment – There is no “E” in “ME” anymore. The 50% deduction that was allowed for meals and entertainment in the past is now available only for meals.
Saved the Best for Last: Research and Development Credit
The research and development (R&D) credit has been preserved; no changes. So why was this included? This is a tax credit that our farming and ranching friends could benefit from. There are many reasons this benefit is being underutilized, from taxpayers not knowing it exists to taxpayers having a tax service provider who doesn’t have the technical expertise to calculate it or taxpayers simply not realizing they are conducting activities that qualify for the credit. Developing or improving processes for breeding livestock/plants, harvesting, and soil development are just a few examples of activities that may qualify. Recently, I traded thoughts with Christina Schultz, one of the R&D experts here at Wipfli. Here is what she had to say:
“The R&D credit has been around since 1981; however, over time the rules/law have changed. With those changes come new opportunities that didn’t exist before and new applications of the law (how it applies to the activities conducted as a taxpayer/industry).
Wipfli has a group of R&D experts devoted to helping taxpayers identify activities and respective costs that can qualify for the credit and expand the credit they may already be claiming by identifying additional opportunities or cost(s) that can qualify and assisting in supporting the credit (if audited).”
This is one area where it never hurts to seek more information. If your current provider doesn’t have the expertise, we’d be happy to consult with you.
In conclusion, I’m reminded of that saying, “You don’t know what you don’t know.” I hope this article has identified some things that maybe you didn’t know before but you know enough about now to have a productive discussion with your tax service provider. At a time when there is much change in the tax law, there is no better time to reach out and take advantage of the benefits!