Under the old tax laws, a farmer who had a bad year could create a net operating loss (NOL) that was allowed to be carried back five years to offset income reported in that year plus any subsequent years if the loss was that large. The farmer could also elect to carry the loss back only two years (if that was a high income year) or elect to carry the loss forward for up to 20 years.
A net operating loss carryback could also impact the farmers ability to use farm income averaging for subsequent years in a positive way. Also, a farmer who had received a subsidy from the USDA and/or a loan from the CCC was only able to deduct a loss equal to the greater of $300,000 or the total net income earned from farming over the last five years. This provision essentially prevented a farmer from carrying back more than a $300,000 loss in most cases.
The new tax law has changed all of these rules and most of the changes are not good for farmers. Here are some the key changes:
- A farmer can only carry back a loss 2 years. All other taxpayers are unable to carry back any losses. However, loss carry forwards do not expire after 20 years. Remember, this is only for farm losses. A farm may have net income from farming but a large business loss on Schedule C. The farmer may believe they can carry back this loss. The answer is no. You can only carry back an actual farming loss.
- Any loss that is either carried back or carried forward can only offset 80% of taxable income in that year. This means that 20% of a farmer's income will be taxed in a year of NOL carryback or carry forward. Plus this can substantially reduce the benefit of any Section 199A deduction earned in that year.
- For C corporations with a fiscal year ending in 2018, non farm losses cannot be carried back. Farm losses can be carried back but only for two years. Some commentators believe this was an error by Congress. I believe they knew what they were doing and this was on purpose to generate revenue.
- The maximum aggregate loss that can be deducted in any one year is now $500,000. The law eliminated the old excess farm loss rule (described previously) and replaced it was the new provision that indicates a taxpayer adds all of its business income, losses and gains together. If this net number is a loss, then it is limited to $500,000 and the excess is carried forward as part of an NOL. Essentially, the maximum loss carryback will be $500,000.
Let's look at an example:
- John operates a farm and incurs a Schedule F farm loss of $750,000 during 2018. His wife has wage income of $100,000 and no other income. The net business loss for the year is $650,000 (we believe that wages is considered business income at least under the old NOL rules). This loss is greater than $500,000, therefore, John can carry back $500,000 to 2016 and carry forward $150,000 or he can elect to carry forward all $650,000 to 2019. He elects to carry it back to 2016 where he reported $500,000 of net taxable income. He can only use $400,000 of the loss to offset taxable income. The remaining $100,000 is carried forward to 2017 where he had $400,000 of income and he can reduce his income by the remaining $100,000. In some cases, the ability to only offset 80% of taxable income is a good thing since it keeps the lower tax bracket income in place. For 2016, the $100,000 of income not allowed to be offset by the NOL is taxed at 10% or 15% (about $25,000 at 25%).
Due to the new laws, most farmers should plan to not create net operating losses due to these rules. To prevent these losses, farmers have multiple options they can use:
- Elect out of 100% bonus depreciation on some or all asset classes (for example take bonus on 15 year property but not on 5 or 7 year property),
- Elect to bring some deferred payment contracts into income in the current year,
- Do not make the de minimis election to expense all assets under $2,500 (this can also help increase your Section 199A deduction),
- Elect to capitalize appropriate fertilizer costs,
- Elect to capitalize all repairs,
- Use Section 179 to reduce taxable income to appropriate levels to soak up the 10 and 12% tax brackets and standard deduction, etc.
If a farmer had a NOL carry forward from 2017 to 2018, the law continues to allow the farmer to offset 100% of taxable income until the NOL expires or is used up. This is on a first-in first-out basis.
As you can see, the new tax law continues to add complexity to our tax planning. We will need to spend even more time before year-end to determine the appropriate amount of taxable income or in certain cases, net operating losses. It won't always be easy to get to the right number.