Now that President Donald Trump is in the White House and Republicans are in control of the House and the Senate, it is almost a guarantee we will have tax reform this year. There will be major changes that affect farmers.
Normally, I would wait to write this column. But farmers might make major financial decisions soon based on current tax laws, and reform could dramatically change their results. I will list some likely reforms that will both benefit and hurt producers’ businesses.
Beneficial Opportunities. First, one of the major goals of tax reform will be to reduce the top corporate tax rate from 35% (almost the highest in the world) to between 15% and 20%. This will allow multi-national companies to compete with firms based overseas. It should also prevent U.S. companies from doing a corporate inversion to move their headquarters abroad.
A top corporate tax rate between 15% and 20% is very good for farmers operating as a regular corporation. Yet what about the majority of farmers who operate as a sole proprietor, a partnership, a limited liability corporation or an S corporation? It is likely the top individual tax rate will drop from 39.6% to 33%, and if the top corporate tax rate is only 15%, there will be a substantial incentive for farmers to convert their farms to corporations.
To minimize this incentive, it is probable the top tax rate for business income will drop from 39.6% to 25%.
Second, most farmers take advantage of Section 179 (up to $500,000) and bonus depreciation. If tax reform happens, farmers will be allowed to immediately deduct business investments such as equipment and buildings. Yet land will not be allowed as a deduction. Section 1031 exchanges might remain for sales of land and perhaps for investment and rental properties.
Third, the estate tax might go away—at least for 10 years. Today, farm couples worth up to about $11 million do not owe federal taxes. Yet under tax reform, the estate tax might be eliminated. There is a chance it will be replaced with a capital gains tax at death, or step-up in basis at death will be curtailed or reduced. Gift taxes might remain in place.
Fourth, most taxpayers have to calculate their income taxes under two methods, either the regular method or an alternative minimum tax (AMT). Tax reform would repeal the AMT.
Fifth, House Republicans have proposed a destination-based cash-flow tax to replace corporate and business income tax. The key features are:
- Sales of exported products would be non-taxable.
- Imported inputs would not be deductible.
- Wages would be allowed as a deduction.
- Net bottom-line income would be taxed at 20% for corporations and 25% for pass-through entities.
If approved, this could substantially reduce many farmers’ tax burden if most production is exported.
Negative Proposals. Let’s turn our attention to some likely reforms that would challenge the way farmers manage taxes. First are changes to business interest. Today, farmers who purchase business assets and finance it with debt can deduct all of the interest. Under reform, business interest could be deducted against only business-interest income.
Second, payroll taxes could dramatically increase. Dividends from S corporations are not subject to self-employment tax, and income from LLCs might be partially exempt. Under reform, an automatic 70% (or some other number) of total farm income will be subject to payroll taxes. With the 15.3% FICA and Medicare rate now being assessed on income over $120,000, a figure that is on its way to $200,000 in a few years, the payroll tax increase might more than offset income-tax reduction.
Third, producers today can deduct about 9% of net farm income (subject to limitations) on income tax returns. Under reform, this is likely to be eliminated.
Farmers need to be aware of how tax reform might affect them. If they don’t, actions taken might cost them a substantial amount.