Farmers can lower their taxable income and plan for the future of their operations by taking advantage of several provisions included in the recently approved American Taxpayer Relief Act of 2012, says The Farm CPA Paul Neiffer.
Neiffer provides a quick video analysis:
Read on to learn about changes to capital gains, Section 179, bonus depreciation, the federal estate tax and the alternative minimum tax (AMT). Click on the links included throughout the article to read additional analysis of the tax changes in Neiffer’s blog.
Capital gains rates multiply
Whereas the federal government previously recognized two capital gains rates–0% for couples whose taxable income was less than about 70,000 and a flat 15% for those making anything above that–it now effectively recognizes at least 10, Neiffer says. Capital gains rates most often affect farmers who purchase farmland and later sell it at a higher price. The difference between the purchase price and the sale price is taxed at the relevant capital gains rate.
(Read more in The Farm CPA blog: Up to Ten Capital Gains Tax Rates for 2013!)
Under the new law, factors affecting the capital gains rate include income bracket, itemized deductions, gross income and personal exemptions. For example, a farmer who itemizes deductions and has a gross income above a certain level will experience phaseouts of itemized deductions and personal exemptions. A Medicare surtax also comes into play for people in some higher-income brackets.
In general, most farmers making less than $250,000 per year will pay a capital gains rate of 15% starting with the 2013 tax year, Neiffer says. The 0% rate will still apply for lower -income taxpayers. Those making above that amount generally will pay a tax rate between 19% and 25%, based on taxable income. In the case of couples with a large family, the effective rate maybe even higher.
High-level Section 179 deduction extended
Farmers who have benefited from the Section 179 deduction for farm equipment and some land improvements will continue to enjoy a high deduction amount of $500,000 for the 2012 and 2013 tax years, Neiffer says. For the years before the Sept. 11 attacks, the deduction never amounted to more than $25,000. For the last several years, the deduction has fluctuated between $125,000 and $500,000 in an effort to encourage machinery buying and stimulate the economy. The deduction will drop back to $25,000 in 2014.
(Read more in The Farm CPA blog: Section 179/Bonus Depreciation)
Farmers would normally depreciate a piece of machinery over a period of seven years. But the extension allows an operator to deduct up to $500,000 of equipment placed into service during the fiscal year for which he or she is filing taxes, Neiffer says. For example, a farmer with a net income of $300,000 who has already completed pre-payings and deferred all sales might purchase machinery at the end of the year to drop their income, reducing the taxes they’ll pay.
The deduction isn’t available to farmers who purchase more than $2.5 million worth of equipment in a year, Neiffer says, but that doesn’t apply to many farmers.
Bonus depreciation extended at 50%
Farmers who put new assets such as equipment and machine sheds into use between Jan. 1, 2012 and Dec. 31, 2013 can take advantage of a 50% deduction known as bonus depreciation. There is no investment limit or taxable income limit for that deduction, Neiffer says.
A farmer who builds a shop for $250,000, for example, can immediately deduct $125,000. The only stipulation is that the assets in question must be new, not used, he says. As with the Section 179 deduction, bonus depreciation initially went into effect to stimulate the economy after Sept. 11. Before 2009, bonus depreciation fluctuated between 0% and 50%. It rose to 100% for part of 2010 and all of 2011.
Federal estate tax rate becomes permanent
The federal estate tax is applied upon a farmer’s death. Whether a farmer’s survivors must pay the tax is determined by taking the total fair market value of his or her assets and subtracting any liabilities. If the resulting net worth is less than the lifetime exclusion, no taxes are owed. If the resulting net worth is greater than the exclusion, taxes are due.
(Read more in The Farm CPA blog: Some Major Tax "Goodies" in Senate Bill for Farmers)
For 2012, the lifetime exclusion is $5.12 million, and that figure will rise to $5.25 million for 2013, Neiffer says. Couples can be worth up to $10.5 million without having to pay the estate tax. That amount is indexed for inflation. Under the new law, the estate tax rate rises from 35% in 2012 to a permanent 40% in 2013. Portability for spouses also has been made permanent.
That means a farmer who doesn’t make any taxable gifts during his lifetime and dies with a net worth of less than $5.25 million will not owe any estate tax, Neiffer says. By contrast, a farmer with a net worth of $10 million will owe taxes at a rate of 40% on assets above the $5.25 million exclusion.
While the $5 million annual exclusion will only remain in effect until Congress decides to change it, Neiffer says, the permanence provides added security to farm families. It follows changes made in 2010, when Congress raised the lifetime gift exemption amount–which had for years stayed at $1 million–to equal the estate tax exclusion.
That means farmers should look at making gifts during their lifetime, Neiffer says. For example, a farm couple worth $10 million might make gifts to stay below that estate value. One possible drawback is that capital gains taxes may be owed when the gifted property is sold. These capital gains taxes are assessed at a lower rate than estate taxes. Any property transferred after that couple’s death would not result in capital gains taxes for the beneficiaries (additional gains above the estate value would be subject to capital gains taxes).
Alternative minimum tax changes help middle-income farmers
Middle-income farmers stand to benefit from changes to the alternative minimum tax (AMT), Neiffer says. Congress decided to index that tax to inflation permanently, meaning affected farmers will avoid seeing a possible annual tax increase of between $2,000 and $12,000.
The tax introduced in 1986 wasn’t originally indexed to inflation, meaning Congress had to pass a patch every one to two years to increase the exemption amount, Neiffer says. The tax affects about 5 million people. Without a patch, the tax would have affected about 30 million people making between $50,000 and $200,000.
That doesn’t mean all middle-income farmers are exempt from AMT, Neiffer says. It simply means the rate will remain lower than it might have been.
Start planning for 2014
The fiscal cliff legislation clarifies the tax landscape for 2013, Neiffer says. But because it’s unclear what changes will be made in 2014, farmers should look ahead.
For example, those who need new equipment might be inclined to purchase it this year to take advantage of bonus depreciation and Section 179. And farmers with a net worth greater than $5 million can’t just sit back.
"They really need to be working with their tax adviser to update that estate plan each year to make sure they stay under than $10 million level," Neiffer says.