It was a long, slow haul to get tax reform approved, but late in 2017 the Tax Cuts and Jobs Act was officially signed by President Donald Trump and is now the law. However, the intent of Section 199A to provide a tax cut for individuals, as compared to corporations, was flawed and Congress finally “fixed” it in late March.
Here are some thoughts on the major items applicable for farmers and their families regarding income and estate tax planning:
Lifetime Exemption. The lifetime estate and gift tax exemption amount was scheduled to be $5.6 million for 2018. Tax reform doubled this amount but a new definition of inflation caused the final 2018 exemption to be $11.18 million (instead of $11.20 million). This is favorable for many of our farm families; however, the exemption is scheduled to revert to 2017 levels in 2026.
The higher exemption provides a great planning opportunity for farm couples worth more than $10 million. Under the old law, there was a chance your estate might be subject to an estate tax. With the new law, farmers worth in excess of this amount should seriously consider making large lifetime gifts to their kids and grandkids (perhaps through a trust).
One reason not to make lifetime gifts is because they do not get a step-up in cost basis. However, if the gift is land and it will be held by the family for many decades, the step-up has little or no value. Most of these farmers’ net worth is land.
Individual and Corporate Tax Rates. The top corporate tax rate was 35%, but the tax reform lowered it to a flat 21% (or a 40% reduction). Many farmers historically only paid corporate tax at 15%, therefore, this is actually a 40% increase for these farmers. Also, Section 199 DPAD is no longer allowed for corporations (or any other taxpayer).
Individuals saw almost all their tax rates drop up to 30% (part of the 33% tax bracket is now 24%) and the top tax rate is now 37%, down from the old top 39.6% tax rate.
To keep individual tax rates competitive with lower corporate tax rates, Congress put in place a new Section 199A deduction. To summarize, this deduction should allow a farmer to reduce their net farm income by 20%.
However, until we get guidance from the IRS, we don’t know how this will work for crop share landlords, self-rentals and many other situations. But it is a major benefit to most farmers, and once we receive guidance, appropriate strategies should become more apparent.
Bonus Depreciation and Section 179. Section 179 has been permanently doubled to $1 million and will start to phase-out at the $2.5 million level. Even better news is bonus depreciation has been bumped to 100% and now applies for all assets a farmer buys even if purchased used (other than land). However, beginning in 2023, bonus depreciation begins to drop by 20% each subsequent year.
Section 1031. Farmers will now have to recognize a gain or loss when selling farm equipment. For farmers in a state with no income tax, this actually provides a tax benefit because gain is not subject to self-employment tax. However, most farmers do have a state income tax, and this will require them to report more net income because most states do not allow bonus depreciation and enhanced Section 179.
Loss Limitations. Finally, farmers are only allowed to carry back losses two years (previously it was a five-year carry-back), and these losses can now only offset 80% of taxable income. Any losses incurred before 2018 will continue to offset 100% of taxable income until fully used.
Many planning opportunities will become apparent once we receive guidance from the IRS. Begin the discussion with your tax adviser now so you can take quick advantage of those opportunities.