The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
When Congress Says "Simplified" Watch Out
Mar 13, 2013
WARNING - THIS IS MY LONGEST POST EVER
The House Ways and Means Committee just issued a proposal to "simplify" the treatment of small business (including most of our farmers). I will attempt to summarize it:
- Permanently expanding Section 179 from the current $25,000 level (for 2014) to $250,000 with a phase-out starting at $800,000,
- Allowing all taxpayers to use the cash method of accounting if their annual sales are less than $10 million (most farmers can use this already),
- Somehow they believe making partnership tax returns have a due date of March 15, S corporations have a due date of March 31 and C corporations have a due date of April 15 will help tax compliance (this assumes a calendar year-end and individuals remain at April 15)
There are two options regarding S corporations and partnerships:
Option #1 offers changes as follows:
For S Corporations:
- Reduce to five years the built-in period (GOOD),
- Increase to 60% the portion of an S corporation's earnings that may be passive without triggering an entity-level tax and eliminate the rule that terminates an S corporation if it has excess passive income for three consecutive years (GOOD),
- Simplify the procedure and extend the time for making an S corporation election, permitting it to make the election on its first tax return (GOOD).
- Repeal the rules relating to guaranteed payments to partners, replacing with treating payments as either payments in their capacity as partners or as non-partners (MAYBE GOOD),
- Require mandatory adjustment of partnership's basis in partnership property when a partner distributes property or transfers his interest (Normally anytime the word mandatory is in the law, it is BAD),
- Clarify that all distributions of inventory are treated as a sale between the partnership and partner (most likely BAD),
Option # 2 - New Simple, Unified Pass-through Rules
This option would repeal current Subchapter K (partnership rules ) and Subchapter S and replace it with one uniform set of rules.
- It would encourge the formation of new businesses by allowing contributions of property and money on a tax-free basis (GOOD),
- Maintain the current relationship that the character of the income and loss pass through to the owners (NO CHANGE),
- Reduce the use of complex structures to engage in tax avoidance by permitting only net ordinary income or loss, net capital gain or loss and tax credits to be specifically allocated (THIS IS WHEN YOU HAVE TO WATCH OUT),
- Close the tax gap while also "simplifying" owner's current quarterly estimated tax responsibility by requiring entity-level withholding on the pass-through income (THIS MEANS THEY WANT THEIR MONEY SOONER AND YOU HAVE TO WAIT TO GET YOUR MONEY BACK IF DO NOT OWE ANY TAXES),
- Prevent owners from gaming the system by using losses to reduce tax liability by limiting deductions for losses to an owner's basis in the pass-through interest, but allowing excess losses to be carried forward indefinitely (WHEN THEY USING THE WORD GAMING "WATCH OUT"),
- Ensure that taxes are paid on real, economic gains (but not on returns of capital) by limiting tax-free distributions to the owner's basis in the business (MOST OF THIS IS IN EFFECT NOW),
- Prevent the use of pass-through entities to shift gains and losses by requiring pass-through entities to recognize gain on all distributions of appreciated property (OUCH FOR PARTNERSHIPS),
- Conform to the basis rules that currently apply to partnerships by allowing owner's basis in their ownership interests for entity-level debt (both recourse and non-recourse) (THIS IS GOOD)
- Provide certainly with respect to owners who actively participate in the business by allowing them to be treated as employees (COULD BE GOOD).
As you can see, I probably just set my new record for longest post ever, but in my opinion these rules are the first step in Congress taking away the flexibility that farmers have enjoyed for the last several decades on the proper use of partnerships, corporations and limited liability companies.
The proposal does not address the employment and self-employment taxes of partners and shareholders and with this year's implementation of the 3.8% Medicare/net investment income tax on all income except pass-through income from material S corporations, it would not surprise me that all business income will become subject to this tax very soon.
It seems like every time Congress uses the term "Simple" it simply means an easier way for them to get more money from farmers. We shall see.