The Tax and Jobs Act will impact all taxpayers in 2018. Taxpayers involved with the agriculture industry should consult with their tax advisors to see if there are steps that should be taken before year-end in preparation for the new law. A few include:
- Farmers should consider the benefit of making equipment purchases or trades in 2017, taking advantage of income deferral opportunities and prepaying farm expenses.
- Farmers with net operating losses from previous years should carefully consider best options since net operating losses carrybacks for agricultural businesses will be restricted from five years to two in 2018.
The Iowa State University Center for Agricultural Law and Taxation have outlined some key ag-related provisions in the sweeping tax legislation: lowering tax rates for pass-through business income, first-year bonus depreciation and expensing and other ag-related items:
Lowering Tax Rates for Pass-Through Business Income
From 2018 through 2025, the Act would generally allow many individuals receiving income from a pass through business—including a sole proprietorship, an S corporation or a partnership—to take a new Section 199A deduction.
- Qualified Business Income: These individuals could generally deduct 20 percent of “qualified business income,” defined as the net amount of income, gain, deduction, and loss attributable to a domestic trade or business, from their taxable income. Qualified business income is determined separately for each qualified trade or business of a taxpayer. Qualified businesses income does not include investment income, such as that from capital gain or dividends. It also does not include reasonable compensation received by an S corporation shareholder or guaranteed payments received by a partner in a partnership. Income from REIT dividends and qualified cooperative dividends, however, would be eligible for the 20 percent deduction. Qualified cooperative dividends would include patronage dividends and per-unit retain allocations.
- Wages Limitation: The 199A deduction would generally be limited to 50 percent of W-2 wages paid (like the current DPAD deduction). However, the wages limitation would only apply to individuals with taxable income greater than $315,000 (MFJ) or $157,500 for singles. Once these income levels are reached, the limitation would be phased in for the next $100,000 of income (MFJ) or $50,000 for singles. Individuals with income above these levels would be fully subject to the wages limitation. The wages limitation does not apply to income from REIT dividends or qualified cooperative dividends.
The Act incorporates an alternative capital component when calculating the wages limitation (for those taxpayers with taxable income above the threshold amount). The wages limitation is the greater of the following:
- 50 percent of the W-2 wages paid with respect to the qualified trade or business, or
- The sum of 25 of percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.
- Service Trade or Businesses: Specified service trade or businesses are generally excluded from taking the Section 199A deduction. Like the W-2 wages limitation, however, this restriction is phased in, based upon taxable income. The services business limitation would begin to apply to taxpayers with taxable income greater than $315,000 (MFJ) or $157,500 for singles. Once these income levels are reached, the limitation would phase in over the next $100,000 of income for MFJ or $50,000 for singles. A specified service trade or business is defined in the Act as follows:
Any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.
- Agricultural or Horticultural Cooperatives: Specified agricultural or horticultural cooperatives would also be eligible for the Section 199A deduction. The deduction is 20% of the cooperative’s excess gross income over qualified cooperative dividends (qualified cooperative dividends include patronage dividends, per-unit retain allocations, and qualified written notices of allocations). The deduction, also beginning in 2018 and eliminated in 2026, would be subject to the wages limitation detailed above.
- Trusts and Estates: The Act provides that trusts and estates would generally be eligible for the 20-percent deduction.
- Calculating the Deduction: A taxpayer’s Section 199A deduction may not exceed his or her taxable income, reduced by net capital gain. It is also important to note that the Section 199A deduction would reduce taxable income, not adjusted gross income. As such, limitations based upon AGI (such as payment limitations for farm programs) would not be impacted by the deduction. Taxpayers would not be required to itemize to claim the Section 199A deduction.
First-Year Bonus Depreciation and Expensing
- Additional First-Year Depreciation: The Act would significantly expand current cost recovery options for businesses for five years and then reduce those options through 2026. The Act would generally allow 100 percent bonus depreciation for five years for qualifying property acquired and placed into service on or after September 27, 2017 (taxpayers could elect to use 50 percent bonus for 2017 purchases). After five years of 100 percent bonus, the Act would then allow one year (2023) of 80 percent bonus, one year (2024) of 60 percent bonus, one year (2025) of 40 percent bonus, and one year (2026) of 20 percent bonus. After that time, bonus depreciation would end. Notably, the Act provides that these first-year additional depreciation property provisions would apply to used property, as well as new property. Property acquired before September 27, 2017, but placed in service after that date, would be subject to present-law phase-down limits.
- Section 179: Beginning in 2018, the Act would expand Section 179 to provide an immediate $1 million deduction (up from $510,000 in 2017) with a $2.5 million phase-out threshold (up from $2,030,000 in 2017). These amounts would be indexed for inflation beginning in 2019. These provisions would not expire.
Other key ag-related provisions include:
- Farm Equipment Depreciation: Beginning in 2018, the Act would allow farm equipment to be depreciated over a period of five years, instead of seven years. It would also remove the requirement that farm property is depreciated using the 150 percent declining balance method (except for 15 or 20-year property).
- Business Interest Limitation: Although the Act restricts business interest deductions generally to 30 percent of adjusted gross income (beginning in 2018), those restrictions would not apply to businesses with revenue below $25 million. The Act also allows a farming business (as defined in IRC § 263A(e)(4)) and agricultural cooperatives to elect not to be subject to the business interest limitation. Such farming businesses, however, would then be required to use the alternative depreciation system to depreciate any property used in the farming business with a recovery period of ten years or more.
- Net Operating Losses: Beginning in 2018, the Act eliminates the two-year carryback of net operating losses (five-years for farming businesses), but allows a two-year carryback of net operating losses in the case of certain losses incurred in the trade or business of farming. It also limits the net operating loss deduction to 80 percent of taxable income for losses incurred after December 31, 2017.
- Like-Kind Exchange: The Act retains IRC §1031 like-kind exchange treatment for real property, but eliminates it for personal property, such as farm equipment or breeding heifers. The increase in expensing options should lessen the impact of this change.
- Domestic Production Activities Deduction: The Act would eliminate the domestic production activities deduction (DPAD), which is frequently used by agricultural producers and cooperatives, beginning in 2018. The new 20 percent deduction for pass-through businesses is much like an expanded DPAD.
- Cash Accounting: The Act would expand the number of taxpayers who may use cash accounting. Most taxpayers that meet a $25 million gross receipts test would be eligible to use the cash method, including any farming C corporations.
Year-end planning options are all highly individualized decisions that will be dependent on taxpayers’ unique situations. Read more here about key provisions in the new legislation for individuals and corporations.
Contact your BerganKDV advisor if you have questions about now the new law may affect you.