Congress finally passed a new tax bill to eliminate most of the fiscal cliff tax effects. Many of the bill’s provisions are favorable to farmers.
For individual income taxes, most of the "Bush era" rates were maintained. The only change is an increase in the maximum rate from 35% to 39.6% on taxable income of more than $400,000 for singles and $450,000 for married couples. Couples are penalized: If two singles each make $400,000, neither pays the maximum tax rate. If a married couple earns $800,000, $350,000 is taxed at the highest rate.
"Tax planning can have some certainty this year, but work is still needed to stay out of the maximum income and capital gains tax rates."
Deduction and Exemption Phaseout. These rules applied years ago and were scheduled to come into effect again in 2013. Here, Congress increased the "applicable threshold" levels to $250,000 for singles and $300,000 for married couples. Above these levels, 3% of itemized deductions will phase out, and for every $2,500 increase in income, 2% of personal exemptions will be eliminated.
Capital Gains and Dividend Tax Rates. The bill raises the maximum long-term capital gains and dividends rates to 20% from 15%. However, the phaseout of certain itemized deductions and personal exemptions plus the 3.8% net investment income tax means taxpayers with gross income exceeding $200,000 for singles and $250,000 for married couples will see a maximum capital gains tax rate closer to 25%.
For example, a couple with taxable income between $300,000 and $425,000 will have a maximum capital gains rate of about 24%. If their taxable income is between $425,000 and $450,000, the maximum capital gains rate drops below 20%. Even though their income goes up, their rate goes down.
Alternative Minimum Tax Relief. The IRS estimated that 25 million additional taxpayers would have been subject to the Alternative Minimum Tax (AMT) in 2012 if Congress did not extend the AMT patch. The patch increases the AMT exemption to reflect inflation between 1986 and 2012. Congress went one step further and made this inflation adjustment permanent.
Estate and Gift Taxes. The new bill makes many estate tax provisions permanent. Among the major provisions: the current unified gift and estate lifetime exclusion amount is set at $5 million and indexed for inflation; the maximum gift and estate tax rates are increased from 35% to 40%; and portability of the unused exemption amount of the estate of the first spouse to die. This allows the unused portion to be transferred and used by the surviving spouse and made available for estate and gift tax purposes.
Section 179 Deduction. The new bill retains the maximum Section 179 deduction at the 2010/11 level of $500,000 for 2012 and 2013. This deduction is not reduced until your asset purchases exceed $2 million. For 2014, this deduction is expected to revert to $25,000. Unlike bonus depreciation, Section 179 is based on when your tax year begins. This deduction is allowed for most farm asset purchases, with the exception of farm buildings such as a machine shop or barn.
Bonus Depreciation. A 50% bonus depreciation has been extended for new assets purchased by Dec. 31, 2013. Unlike Section 179, bonus depreciation applies to all new farm assets placed in service by that date. Therefore, constructing and placing in service a new machine shed or shop before Jan. 1, 2014, will qualify for 50% bonus depreciation.
Conclusion. Tax planning can have some certainty this year, but work is still needed to stay out of the maximum income and capital gains tax rates. Plus, if you have a taxable estate of at least $5 million, you must continue to use annual estate planning tools. It’s a good time to get started.
Paul Neiffer is a tax accountant with CliftonLarsonAllen and author of the blog The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at firstname.lastname@example.org