The new tax code requires the 20% Section 199A deduction to be calculated for each separate business. Most farm operations operate in a multi-entity structure: an entity as the “farmer,” one or more entities to own the farmland that is rented to the “farmer” and perhaps even other entities to hold the equipment and rolling stock.
The New Rules. The IRS proposed regulations released in August give us some answers. Farmers who have land rented to an entity that are both under common ownership automatically qualify the cash rent farmland as “qualified business income” (QBI). Common ownership requires all the entities to be held at least 50% by the same persons. It does not require any one person to own 50%, but rather the joint ownership needs to be at least 50%.
For example, three brothers farm as an S corporation and rent all their land from an LLC owned by all three. Even though no brother owns more than 50%, this is considered 100% common ownership.
If, however, each brother leased their ground to the S corporation, this would not be common ownership. As a result, none of the cash rent income qualifies for the Section 199A deduction, even if their taxable income was under the threshold.
Now for farmers over the income threshold ($315,000 for married couples and $157,500 for all others), the new regulations allow farmers to “aggregate” commonly owned entities into one entity. This can allow cash rent entities with no wages to be aggregated with farm entities with wages to maximize the Section 199A deduction.
For example, assume the S corporation owned by the three brothers paid $400,000 of wages and netted $200,000. The cash rent LLC netted $1 million but paid no wages. Without aggregation, the S corporation income would net a $40,000 Section 199A deduction but the LLC would result in zero deduction due to no wages paid or qualifying property. With an aggregation election, the brothers would now split a $200,000 Section 199A deduction (an increase of $160,000). The maximum deduction would be $240,000 but 50% of the wages limited it to $200,000 (ignoring qualified property).
Non-Farming Landlords. What about landlords who don’t farm? Many commentators assumed all rental income would qualify for the new Section 199A deduction. But the proposed regulations said the deduction is only for qualified business income and rents are not business income. The income can rise to the level of a trade or business if the landlord performs enough services related to the rental.
In a normal cash rent arrangement, the landlord doesn’t perform services, thus it is not business income. If you are a non-farming cash rent landlord, you will likely not qualify for the 20% deduction.
Now for crop-share landlords, it might be different. Crop-share income qualifies for farm income averaging whereas cash rent does not. Also, some other regulations indicate that if the landlord shares in enough of the expenses of the farm, then it is more likely treated as a joint venture and thus, a trade or business.
We believe that crop-share landlords who participate in the expenses of the farm will qualify for the deduction. If they simply receive a share of the crop and pay no share of expenses, it will likely be treated just like cash rent and no deduction.
What should you do? For now you do nothing, because these are still proposed regulations. If the final form is the same, you might want to consider changing to a crop share if the deduction is large enough to reduce your taxable income. Remember, if your taxable income is over a threshold amount, then no or little deduction will be allowed anyway because you have no wages or qualified property.
Read the latest analysis and information about Section 199A at bit.ly/Section199A
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.