I am hoping this will be final column on the Section 199A 20% Qualified Business Income (QBI) deduction. The IRS issued the final regulations on Friday, Jan. 18 (I will always remember that date because it’s my birthday). Most of the changes in the final regulations were fairly minor, but several of the changes will affect farmers in a material way.
These final regulations added some needed clarity to the Section 199A 20% deduction. But some parts will require us to use our professional judgement. Be patient with us this tax season. It will be easier next year (I hope). Here are some common questions.
Will land rental income qualify for the deduction?
In almost all cases, your farmland rental income will qualify for the deduction if you or your business entity is paying the rent. You only need the same people to own at least 50% of the land entity and farm operation. Once you hit the 50% level, all the rental income qualifies as QBI, even if one of the rental owners are not part of the farm operation.
The proposed regulations indicated brothers and sisters are not related parties, but final regulations indicate siblings are actually related parties. Even cousins are related parties if one of the common grandparents is still alive. This makes it much easier for the land rent to qualify as QBI.
For example, assume John is the farmer and his sister, June, owns the land. He pays $100,000 of rent to his sister. With the final regulations, the rental income qualifies as QBI, even though June doesn’t own the farm.
If my C Corporation pays me rent, will it qualify as QBI?
The proposed regulations were silent on whether rents paid by a C corporation under common ownership qualify as QBI. The final regulations are specific that rents paid by the C corporation are not QBI via common ownership. However, the rental activity may still qualify as a trade or business due to your involvement. In this case, it will qualify as QBI.
However, if you have too much involvement, you are likely facing the prospect of paying self-employment (SE) tax on this income.
This is another reason farmers should consider switching to an S corporation from a C corporation. With the increase in the corporate tax rate from 15% to 21%, and not qualifying your rental income as QBI, the tax hit for C corporation farmers in many cases is much higher than under the old laws.
If I’m not a farmer and I rent my ground to a neighbor, will my rental income qualify?
The IRS did provide a safe harbor for these landlords. However, it is going to be extremely difficult to meet the requirements.
First, it cannot be a triple net lease (NNN). Most cash rent agreements would typically be treated as an NNN lease; thus the safe harbor would not apply.
Second, the safe harbor requires at least 250 hours of work on the land (not simply doing accounting or driving to the property). However, if you were to provide some services, such as mowing ditches, maintaining irrigation systems and share in more costs, then it might rise to the level of a trade or service and does not require the safe harbor. The bottom line for most cash rent farm landlords with no involvement is it will be hard to qualify as QBI.
What other deductions on Form 1040 reduce QBI?
The proposed regulations were silent on additional deductions that show up on Form 1040 that might reduce QBI. We now know there are at least three deductions that will need to reduce QBI. A typical self-employed farmer will need to reduce for their SE tax, health insurance deduction and any retirement plan contributions. There might be other deductions such as interest paid to purchase an S corporation or partnership that will also reduce QBI.
Read a few more answers to questions about Section 199A in Neiffer's blog, The Farm CPA.
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA. He recently purchased a 185-acre farm. Driving his cousin’s combine is his idea of a vacation.