Kansas Farm Bureau Young Farmers and Leaders Conference Manhattan, KS January 26, 2018 The TCJA s Impact on Farmers and Ranchers Roger A. McEowen Kansas Farm Bureau Professor of Agricultural Law and Taxation Washburn University School of Law
Contact Information roger.mceowen@washburn.edu o www.washburnlaw.edu/waltr o @WashburnWaltr o (785) 670-1837
WASHBURN LAW NEW IRC 199A - Background Taxpayers other than C corporations are taxed using the individual rate structure Taxpayers previously were allowed a Domestic Production Activities Deduction (DPAD) o 9% deduction for qualified production activities income The deduction was limited to 50% of wages expense attributable to manufacturing, producing, growing or extracting activities Cooperatives were also entitled to DPAD o Cooperatives could pass all, some or none of the DPAD to patrons 3
WASHBURN LAW New I.R.C. 199A 20% deduction for qualified business income o Eff. for tax years beginning after 12/31/17 and before 1/1/26 o The basic idea is to allow a non-corporate taxpayer to take a 20% deduction against the income from their business activity Sole proprietor S corporate owner Member of partnership Cooperative patron Owner of an interest in a REIT Owner of an interest in a qualified publicly traded partnership o A modified rule applies to a specified service trade or business 4
WASHBURN LAW Basics of 199A, Deduction for Qualified Business Income Taxpayers other than C corporations Applies for tax years beginning after 2017 and before 2026 20% deduction on QBI Specified service business income (SSB) QBI o Exception based upon threshold income plus phase-out range Separate trades or businesses Wages and investment limit applied to each business o Exception based upon threshold income plus phase-out range 5
WASHBURN LAW New I.R.C. 199A Only applies for income tax purposes not s.e. tax or NIIT Determined without regard to AMT adjustments (is allowed against AMT) Is allowed to arrive at taxable income, but not to arrive at AGI o The various phase-ins and phase-outs which are based on AGI are not impacted by I.R.C. 199A Not allowed in determining any NOL Is allowed to itemizers and non-itemizers (even though it is not part of the determination of AGI) Doesn t matter if taxpayer is materially involved in the business activity. What matters is percentage ownership. o Probably need material participation leases o Rent paid by a C corporation cannot be QBI QBI depends on whether taxpayer has ordinary income 6
Farm Program Payment Limitations An AGI limit applies o $900,000 o Computed by using the number shown at the bottom of page 1 of Form 1040 Used to include the DPAD of I.R.C. 199 o Under the new law, I.R.C. 199 is repealed New I.R.C. 199A is not part of the AGI calculation Result could be ineligibility for payment limits o The Farm Bill did nothing to deal with this 7
QBI amount Included/Excluded Items o Does not include reasonable compensation o Does not include guaranteed payments o Does not include wage income (including S corporation shareholder wages) o Does not include capital gain or loss, dividends (or their equivalent) o Does not include any amount received from an annuity that is not in connection with a trade or business o Does not include speculative gains 8
Julie TCJA Example 10 199A Deduction Farm income $150,000 Sole proprietor (1040) Schedule F 150,000 Less ½ SE tax -9,969 Net QBI 140,031 QBI Rate 20% Initial QBI Deduction 28,006 S-Corp (1120S) Schedule F 150,000 Less Julie s wages -55,000 Less employer s ½ FICA -4,208 Net QBI 90,792 QBI Rate 20% Initial QBI Deduction 18,158 9
New I.R.C. 199A For a sole proprietor the entire bottom line amount of Schedule F (or C) qualifies for purposes of the deduction o Thus, the deduction for a sole proprietor may often be larger than if the business were structured as a partnership or S corporation 10
WASHBURN LAW New I.R.C. 199A Income from hedging counts, but income from speculative gain does not count 11
WASHBURN LAW QBID and Capital Gains QBID cannot exceed taxable income of the taxpayer in excess of the sum of net capital gain o Capital gain for this purpose includes all income subject to Sec. 1(h) rates o Includes qualified dividends o Includes unrecaptured Section 1250 gain 12
WASHBURN LAW Capital Gain/Sec. 1231 Gain Example o Cow/calf operation sells raised breeding stock (held for more than two years) $300,000 gain triggered Ordinary income is zero Initial QBID is 20% of taxable income ($60,000) But, QBI doesn t include capital gain Final QBID is zero 13
WASHBURN LAW Capital Gain/Sec. 1231 Gain Example o Cow/calf operation sells purchased breeding stock Purchased 8 years ago for $200,000 and is fully depreciated Sale generates $200,000 ordinary gain (depreciation recapture) and $100,000 capital gain Net QBI is $200,000 QBID is $40,000 14
WASHBURN LAW What About Rental Income? it depends! o IRS considers many rental real estate activities to be nonbusiness o Groupings and other recharacterizations under passive activity rules not applicable o QBI not dependent upon passive, nonpassive or materially participating status 15
WASHBURN LAW Aggregation of Activities Grouping allows wages and QP to be aggregated into a single amount for computing QBID o Requirements: Same person or group of persons directly or indirectly owns 50% or more of each business to be aggregated Ownership exists for most of the tax year All items of each business are reported on returns with the same tax year No business is an SSB Two of the following satisfied: Products and services are the same or offered together Share facilities or significant business elements Operate in coordination with or reliance on one or more of the group 16
WASHBURN LAW Aggregation Prop. Regs. Common ownership is required to allow the aggregation of entities to maximize the QBID for taxpayers that are over the applicable income threshold. o Common ownership requires that each entity has at least 50 percent common ownership. Common ownership of the entities will allow the cash rental income to count as trade or business income for purposes of the QBID, without regard to whether the taxpayer is under or over the applicable income threshold. However, if the taxpayer is over the applicable income threshold, an aggregation election will be necessary to create sufficient wage or qualified property for allow for a full QBID. Many farming operations do not pay qualified W-2 wages, and many will have little to no qualified property (as defined by I.R.C. 199A). Thus, the ability to aggregate the entities is critical to obtaining the QBID. 17
WASHBURN LAW Example Negative QBI o Shorty operates small animal feed manufacturing business as a sole proprietor, and a farming operation. Feed business has net income of $50,000 and farming operation had a $75,000 loss QBL is $25,000 No QBID, but QBL of $25,000 carries forward to next year Shorty will need QBI of $25,000 before QBI in the next year exceeds zero 18
WASHBURN LAW What are Qualified Wages? W-2 wages that are allocable to the QBI of the business Subject to payroll tax Thus, wages paid in commodities don t count Wages paid to kids under 18 by parents do count o They are subject to withholding 19
WASHBURN LAW Cooperative Rule What about income received from an ag cooperative? o The combined QBIA is reduced by the lesser of 9 percent of the QBI that is allocable to qualified payments from the cooperative, or 50% of the W-2 wages associated with the QBI from the cooperative 20
WASHBURN LAW Rules for Specified Ag or Hort Cooperatives Cooperative allowed a 9% DPAD deduction equal to the lesser of o QPAI o Taxable income Taxable income determined without regard to patronage dividends, per-unit retain allocations and nonpatronage distributions Deduction limited to 50% of W-2 wage expense of cooperative Co-op computes 9% deduction on its share of partnership activity Co-op chooses amount to pass to patrons o Deduction cannot be passed to C corporations 21
WASHBURN LAW Impact on Patrons If receive a qualified payment from a cooperative o Can claim a deduction in the tax year of receipt in an amount equal to the portion of the cooperative s deduction for qualified production activities income that is Allowed with respect to the portion of the QPAI to which the payment is attributable; and Identified by the cooperative in a written notice mailed to the patron The cooperative s deduction is allocated among it s patrons on the basis of the quantity or value of business done with or for the patron by the cooperative 22
WASHBURN LAW Qualified Payment to a Patron Patronage dividend or a per-unit retain allocation Received by an eligible patron Attributable to QPAI with respect to which a deduction 23
Sell to a Co-op Or Not? It depends! o Generally If income over threshold, QBI deduction will be larger by paying qualified wages if farmer doesn t have enough qualified property to generate full QBI deduction allowed (max d at 20%) If below the threshold, a larger deduction is achieved by not paying qualified wages, or by paying qualified wages in an amount such that 50% of the amount of the wages paid is less than 9% of the farmer s Schedule F income that is attributable to the cooperative 24
Inflation Adjustments - 2019 Rev. Proc. 2018-57 Bracket top ends: (MFJ) o 10% - $19,400 o 12% - 78,950 o 22% - 168,400 o 24% - 321,450 o 32% - 408,200 o 35% - 612,350 o 37%
Inflation Adjustments - 2019 Bracket top ends (Estates and Trusts) o 10% - 2,600 o 24% - 9,300 o 35% - 12,750 o 37%
Inflation Adjustments - 2019 Adoption credit - $14,080 Standard deduction - $24,400 (MFJ) Sec. 179 - $1,020,000/$2,550,000 QBI thresholds: $321,400/$160,700 Cash method: $26,000,000 EBL: $510,000/$255,000 Unified Credit: $11,400,000 Special Use Max Reduction: $1,160,000
Inflation Adjustments - 2019 Present interest gifts: $15,000 Installment payment 2% portion: $1,550,000 Penalties: o Failure to file partnership return: $205 o Failure to file S corp. return: $205
Standard Deduction Old: S $6,500 HoH $9,550 MFJ $13,000 New: S $12,000 HoH $18,000 MFJ $24,000 Starting in 2019, will be adjusted for inflation* Sunsets after 2025 Zero tax amount o 2017: $20,800 (joint); $10,400 (single) o 2018: $24,000 (joint); $12,000 (single) 29
Standard Deduction with Personal Exemptions 30
Exemptions Old: 2017: $4,050 per person in family, pursuant to 151 New: Eliminated (actually suspended) Elimination will sunset after 2025 31
Child Tax Credit Old: $1,000 per child under 17 New: o CTC of $2,000 per child under 17, $1,400 of that refundable o Non-child dependent tax credit of $500 credit for non-child dependents (grandparents, etc.; non-refundable) Must have SSN for child to claim CTC no requirement for Non-child dependent to have. o Can claim $500 credit for child without S.S. No. Cannot claim Dependent Tax Credit for TP using her/himself or spouse. After 2025 reverts to old provisions (lower CTC, no nonchild dependent credit) 32
Child Tax Credit, continued Income phase-outs are dramatically increased o Old: S$75,000/MFJ$110,000 o New: S$200,000/MFJ$400,000 Thresholds NOT indexed for inflation 33
The Family Tax Credit $500 nonrefundable credit for qualifying relatives that are dependents and not a qualifying child) o Dependent cannot reside in Mexico or Canada Must be a U.S. citizen, national or U.S. resident
The Family Tax Credit Must be o Child or grandchild o Sibling or step-sibling o Parent or ancestor of the above o Niece or nephew o Aunt or uncle o In law o Someone who lived with taxpayer for the tax year and is a member of the household
Old: Children (under 19/F-T students under 24) taxed at their individual tax brackets for earned income, but unearned income above threshold (2017 - $2,100) added to parent s income at their top marginal rates New: Child s unearned income is subject to trust tax brackets which hits 37% at the low threshold of $12,500. Parents making large grain gifts face increase in tax rate from 12%-22% to 37% Still save on SE tax Kiddie Tax 36
Capital Gains 37
Capital Gains Breakpoints Filing Status 15% Breakpoint for T.I. starting at: (2018) 20% Breakpoint for T.I. starting at: (2018) MFJ or surviving spouse $77,200 $479,000 Head of household 51,700 452,400 MFS 38,600 239,500 All other individuals 38,600 425,800 Estates and trusts 2,600 12,700
Miscellaneous Itemized Deductions State and Local Taxes o Old: can deduct property and either state sales taxes or state income taxes o New: limited to a combined $10,000 for property or income/sales taxes (note taxes paid or accrued in COTB not limited). $10,000 limit applies for both individuals as well as MFJ $10,000 (MFJ) $10,000 (single) $5,000 (MFS each) 39
No Limit For COTB Property If it s business property, the $10,000 limitation doesn t apply
TCJA Impact on Charitable Giving Fewer taxpayers will see a tax benefit of giving to charity due to the enhanced standard deduction o Strategy: Prepay charitable via donor-advised fund (DAF) o Strategy: Qualified charitable distributions from an IRA (e.g., SEP or SIMPLE) Excluded from gross income
Mortgage Interest/Home Equity Debt Mortgage Interest o Old: could deduct mortgage interest from first $1M of home debt o New: can deduct mortgage interest from first $750,000 of home debt. Only applies to new mortgages taken out after Dec. 15, 2017 Grandfathering for houses under a binding written contract by Dec. 15, 2017 to close on a principal residence purchased by January 1, 2018 (and actually closed by April 1, 2018) Still applies to both a primary residence and a designated second home Home equity indebtedness no longer deductible (as opposed to acquisition indebtedness that is). No grandfathering available. 42
Deductibility of Interest Look to see how the loan proceeds are applied o Interest on home equity loan used for rental activities Deductible on Schedule E o Interest on home equity loan used COTB Deductible on Schedule C o Interest on home equity loan used for multiple types of expenses Allocate based on use of proceeds
Miscellaneous Itemized Deductions Suspended Suspended: o Employee business expenses o Tax preparation fees o Investment interest expenses o Personal casualty and theft losses except for federally declared disaster areas Modified: o Charitable contributions increased to 60% by 170(b)(1)(G). o Gambling losses: loss from a wagering transaction is modified, while retaining deductibility of gambling losses from gambling winnings. 44
Miscellaneous Itemized Deductions Suspended Suspended: o Various investment expenses Attorney and accounting fees Clerical help Fees to collect income Investment counsel and advice fees Safety deposit box rent Trustee s commissions for revocable trust Investment expenses from pass-through entities 45
Individual AMT Individual AMT reigned in by an increased exemption o MFJ: $84,500 to $109,400 o MFS: $42,250 to $54,700 o Single: $54,300 to $70,300 Phaseouts are higher as well: MFJ: $160,900 to $1,000,000 MFS: $80,450 to $500,000 Single: $120,700 to $500,000 46
TCJA & AMT The higher exemption and phaseout will make it more likely that the typical taxpayer will have a much reduced chance of the AMT applying o Will take a unique set of facts
Depreciation Changes 5-year recovery period for machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer and is placed in service after December 31, 2017. o The provision also repeals the required use of the 150- percent declining balance method for property used in a farming business (i.e., for 3, 5, 7, and 10-year property). o The 150 percent declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight-line method does not apply, or to property for which the taxpayer elects the use of the 150-percent declining balance method. o For these purposes, the term farming business means a farming business as defined in I.R.C. 263A(e)(4). 48
Sec. 179 Depreciation Changes o Max. is $1 million with phase-out threshold set at $2.5 million Indexing after 2018 for both amounts o Includes qualified real property (e.g., roofs and HVAC systems) o Can be used to optimize taxable income if farmer elects out of bonus depreciation 49
Depreciation Changes Sec. 179 o Max. is $1 million with phase-out threshold set at $2.5 million Indexing after 2018 for both amounts o Includes qualified real property Roofs and HVAC systems o Property that is used predominantly to furnish lodging or in connection with furnishing of lodging o SUV amount of $25,000 is inflation adjusted post-2018 o Can be used to optimize taxable income if farmer elects out of bonus depreciation 50
For assets acquired and placed in service after 9/27/17 and before 1/1/23 o New and used property eligible o After 2022 100% expensing ( Bonus depreciation) 80% for 2023 60% for 2024 40% for 2025 20% for 2026 0% post-2026 o For first tax year ending after 9/27/17, may elect 50% allowance instead of 100% o Same rules apply to plants bearing fruits and nuts 51
Bonus Depreciation Used Property 1. Property not used by TP or predecessor any time prior to acquisition 2. Acquisition meets related party and carryover basis requirements 3. Acquisition meets costs requirements Ordering Rules: (1) 179, (2) bonus depreciation, (3) regular depreciation
Observation With 5-yr depreciation on new equipment and 7-yr depreciation on used equipment, a taxpayer could make separate bonus elections o The bigger issue is that a state might not couple on bonus but might couple on the I.R.C. 1031 provision not being available for equipment. 53
Depreciation Example Farmer purchases $500,000 of used equipment, $350,000 of tiling, and buys land with a machine shed worth $500,000 o Under old law, could only deduct $175,000 on the new tiling using 50% bonus depreciation. o Under the new law, the farmer can fully depreciate all $1,350,000 using 100% bonus depreciation o Or can elect out of bonus on any of the assets on a class-by-class basis (7, 15 and 20 year property) 54
Farm Property Depreciation Where Are We Now? Farm property will be depreciated under the 200% declining balance method, except for o Buildings, and trees and vines bearing nuts and fruits (to which straight-line method applies) o Property for which the taxpayer elects either the straight-line method or 150% d.b. method o 15 or 20-year property that has to be depreciated under the 150% d.b. method o Property subject to the ADS 55
For assets acquired and placed in service after 9/27/17 and before 1/1/23 o New and used property eligible o After 2022 100% Expensing ( Bonus Depreciation) 80% for 2023 60% for 2024 40% for 2025 20% for 2026 0% post-2026 o For first tax year ending after 9/27/17, may elect 50% allowance instead of 100% o Same rules apply to plants bearing fruits and nuts 56
For tax years beginning after 2017: o Deduction may be limited to business income plus 30 percent of taxpayer s AGI (computed without interest expense, interest income, NOL, depreciation, amortization, depletion (EBIDTA) EBIT is used beginning in 2022 (depreciation is deducted) o Determined at tax-filer level except for pass-through entities (entity level) [1065; 1120S] o Excess carried forward Business Interest 57
Business Interest If entitled to use cash accounting, no limit o Avg. annual gross receipts not exceeding $25 million for three prior tax years (indexed after 2018) Farm businesses over the limit can irrevocably elect out Likely to be applied on an entity-by-entity basis Must then use ADS on farm property with recovery period of 10 years or more Probably won t be able to use bonus on these assets 58
Like-Kind Exchanges Limited to real property exchanges where the property is not held primarily for sale o Permanent provision New rules (barring non-real estate trades) apply to exchanges completed after 2017 Old rules apply to exchanges of personal property if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before 12/31/17 59
Post-2017 Trades Farmers will still trade equipment o The trade-in value will be listed as the selling price of the traded equipment on Form 4797. The entire asset value is added to the depreciation schedule and would be eligible for bonus depreciation of Sec. 179 o Will the gain reported on Form 4797 be QBI? The QBI deduction does not apply to capital gain The statute does not refer to gain on capital assets Thus, income taxed as capital gain, even though it is from an I.R.C. 1231 asset, is included in the definition of capital gain that is not eligible for the QBI deduction 60
WASHBURN LAW Example Like-Kind Exchange Frank Farmer Prior Law Farm income (before depreciation) $250,000 Old tractor trade allowance $150,000 New tractor trade difference (boot) $250,000 Farm Income 250,000 179 deduction 131,053 1 st year depreciation 12,744 Schedule F 106,203 New purchases 250,000 Less 179 deduction -131,053 Remaining cost 118,947 7-YR 150%DB X 10.714% 1 st year depreciation 12,744 4797 Gain 0 Schedule F 106,203 ½ SE Tax 7,503 AGI 98,700 SD & Exemptions 21,300 Taxable Income 77,400 Income Tax (10% & 15%) 10,658 SE Tax 15,006 Total Liability 25,664 61
WASHBURN LAW Example Like-Kind Exchange Frank Farmer TCJA Farm income (before depreciation) $250,000 Old tractor trade allowance $150,000 New tractor trade difference (boot) $250,000 Farm Income 250,000 179 deduction 249,063 1 st year depreciation 30,187 Schedule F (29,250) New purchases 400,000 Less 179 deduction -249,063 Remaining cost 150,937 5-YR 200%DB X 20.000% 1 st year depreciation 30,187 4797 Gain 150,000 Schedule F (29,250) ½ SE Tax 0 AGI 120,750 Standard Deduction 24,000 199A deduction 19,350 Taxable Income 77,400 Income Tax (10% & 12%) 8,907 SE Tax 0 Total Liability 8,907 62
Trade Implications Net farm income may now become a loss o What if the farmer uses CCC loans? At-risk rules? No QBI deduction because no Sched. F income o And, gains may not qualify for the QBI deduction Get the trade-in value correct 63
Trade-Ins and Self- Employment Tax The 2018 wage base is $128,700 and it will rise to $132,900 for 2019. o 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. What are the implications of the new rules on personal property trades?
Trade-Ins and Self- Employment Tax The new tax law may prevent many farmers from showing any self-employment earnings if they trade farm equipment during the year. o Ex: Assume Bob normally reports $100,000 of net farm income each year. During 2018, Bob trades-in a piece of fully depreciated equipment worth $150,000 on a new piece of equipment. $150,000 gain on form 4797 not subject to SE tax and $50,000 farm loss to get income to $100,000. o Even though Bob reported net farm income of $100,000, there will be no SE tax owed and no buildup in the Bob s social security earnings.
Trade-Ins and Self- Employment Tax How to address the issue: o Bob could elect the optional SE method. Even though Bob showed a loss of $50,000 on his Schedule F, the optional SE method allows the Bob to report $5,280 of SE income. This will result in additional SE tax of about $808, but allows Bob to at least show this amount of income for social security retirement purposes. If Bob needs 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.
Trade-Ins and Self- Employment Tax How to address the issue: o If Bob lives in a state that does not require sales tax on farm equipment, he could transfer all of the farm equipment into an S corporation and have all of the trade-ins incur inside of the corporation. 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, Bob could then take a wage for properly managing the operations of the corporation thus building up his social security retirement benefits. The use of the S corporation could also provide additional legal protection in case of equipment accidents. Additional filing of a tax return; additional payroll to perform, etc.
Form 4797 separates out the I.R.C. 1231 gain, the ordinary income, and the gain attributable to recapture from sales or exchanges of business property o Part I LTCG (not QBI) o Part II not considered STCG (is QBI) o Part III is QBI Form 4797 Mechanics 68
Corporate AMT
p C Corporations Corporate tax rate cut to flat 21%; 16% points lower than the highest individual tax rate of 37%; no change to double taxation Many family farm corporations experience 40% rate increase New 20% QBID not available
RN LAW Corporate Tax Rate New: corporate flat tax of 21%, down from rates (35% in highest bracket). Old: Corporate AMT repealed
As normal rate C Corp. or Pass-Thru? the benefit from QBID When individual marginal income tax rates 24%; QBID reduces effective rate below 21% corp. rate More nonqualifying income = less effect QBID has in lowering effective average marginal tax rate
THANK YOU! roger.mceowen@washburn.edu www.washburnlaw.edu/waltr @WashburnWaltr (785) 670-1837 This Photo by Unknown Author is licensed under CC BY-SA-NC