Summary of Changes
The changes relevant to farming and ranching are to three main categories of the tax code:
- Estate, Gift and Generation Skipping Tax
- Personal Income Tax
- Corporate Income Tax
Estate, Gift and Generation-Skipping Tax
- The exemption amount has doubled to $11.2 million for individuals and $22.4 million for married couples. You can gift or bequeath up to those exemption amounts without paying the 40% federal estate/gift/GST tax.
- Additionally, beginning in 2018, you can gift $15,000 ($30,000 per married couple) to an unlimited number of recipients per year, without it counting against the above exemption amounts. That is a $1,000 per person per year, increase over the 2017 amount.
For example, a husband and wife rancher have 3 children, who each have 2 children of their own (9 gift recipients). They could give $30,000 cash to each of their children and grandchildren per year without affecting their combined $22,400,000 exemption. So, if they both died in an accident at the end of 2025, they could have given away and/or bequeathed $24,290,000, free of the 40% estate and gift tax.
- The high exemption amount ends at the end of 2025, after which it reverts to the current $5,000,000, indexed for inflation ($5,490,000/$10,980,000 in 2017)
- What happens if you and your spouse gift $22.4 million in the next 7 years, but don’t die until 2026 or beyond? Will your estate have to write a check to the federal government for $4.96 million (40% of $12.4 million). The prevailing opinion is no, there’ll be a legislative fix for that. But it is not 100% certain. What if you and your spouse gifted $22.4 million of farmland, stock and equipment? Would your donees have to sell the family farm to pay your estate tax bill after 2025? It is almost certain that a regulation or a law will prevent that. But the “almost” part causes me to leave it in this category.
Personal Income Tax
The rate changes are a mix, but better for many, so I’ll include the chart here:
2018 PERSONAL INCOME TAX RATE CHART
|Rate||Unmarried Individual||Married Filing Jointly||Head of Household|
|Taxable Income Over||Taxable Income Over||Taxable Income Over|
- There are still seven brackets. Based on the rates that would have been in effect for 2018, had there been no tax law change, and not accounting for deductions, unmarried individuals making $157,500 or less will be taxed at slightly lower rates. Those making between $157,500 and $426,700 will be taxed at slightly higher rates. Above $426,700 will be taxed at a lower rate, because the top rate has come down.
- The standard deduction has been raised to $12,000 (Individual), $24,000 (MFJ), and $12,000 (HOH). That’s roughly double.
- The Child Tax Credit doubles to $2,000 ($1,400 refundable), with phase-out beginning at $400,000 for those Married Filing Jointly.
- Expanded use of 529 plan funds.
- The Obamacare Penalty is reduced to $0 beginning in 2019.
- The marriage penalty is retained, though applicable to a smaller percentage of taxpayers. And some higher earners will pay higher rates, especially if they are not able to take advantage of other provisions of the tax laws. For instance, someone earning a good salary as a W-2 employee may pay more than someone earning more than them through their own pass-through business.
- The personal exemption has been repealed, which reduces the benefit of the higher standard deduction.
- Long-term Capital Gains tax rates were not adjusted, so the calculations are a little more complicated, since they don’t align with the new brackets. It isn’t really worse; it just isn’t better.
- 3.8% Net Investment Tax remains unchanged. It should go away if Congress can get on with repealing Obamacare.
- State and Local Tax (SALT) deduction cap of $10,000. If you live in a high tax state, this is not good for you. Or perhaps you maintain residency in a state with an obnoxious long- arm. Expect those states to fight back somehow. If you are in a low tax jurisdiction, this is not a bad development, unless you like to subsidize residents of New York City and L.A..
- There are still seven brackets, and the income tax is still a progressive income tax, meaning productivity is progressively discouraged by your federal government. It prefers dependent subjects.
- 529 Plan extended use of funds fails to cover homeschool expenses. Homeschool families already pay for their children’s educations, as well as others, so to further penalize those who arguably are doing the most to educate future generations makes no sense (many farmers and ranchers homeschool).
- Mortgage interest deduction limit drops down by a quarter of a million dollars for loans originating after December 15, 2017. Loans originating prior to this date are grandfathered. This applies to residential mortgage interest. Interest on home equity debt is no longer deductible at all.
- The “Obamacare Penalty” remains in effect for 2017 and 2018.
- The effect on charitable giving is expected to be negative. Most of us give because we believe in the cause, but sometimes gifts are given specifically because someone (or some entity) needs to reduce their income level, and so they go looking for a worthwhile charity to benefit. With a reduced incentive to itemize deductions, many tax policy wonks project lower charitable giving. I hope not.
Corporate Income Tax
- The corporate income tax rate has been changed to a flat rate of 21%. This is a “permanent” change (which means it won’t change until/unless Congress takes some affirmative action to alter it; it does not automatically sunset in a few years, in other words).
- The expense deduction available under Section 179 for equipment purchases is doubled from $500,000 to $1,000,000. This change is not scheduled to sunset. The deduction cannot exceed taxable income.
- Bonus depreciation under Section 168 has increased to 100% until the end of 2022, after which it is phased out. There has been some shuffling of the property subject to these provisions, a detailed explanation which lies outside this article’s scope. Most of the usual ranch equipment will qualify, and it can be used equipment, as long as it is “new to you.” As long as you aren’t buying it back from someone you sold it to, in other words.
- The application of Section 179 expensing and Section 168 bonus depreciation can also have a positive impact on Section 1245 recapture, resulting in lower Schedule F income, and lower self-employment tax.
- Section 199A Qualified Business Income deduction of 20%. If you are the owner of a pass-through entity, like the Department of Agriculture says 85% of farmers and ranchers are, then you get a 20% deduction on your income from that business. There are limitations and carve-outs, but most ranchers who are pass-through entity owners (sole proprietor, LLC taxed as partnership or s-corp, partnership, s-corp) should benefit from this. This deduction is available to businesses owned in trust, as well. The deduction may also be carried forward if there is a loss.
- Meals provided on-site will be 50% deductible.
- Corporate Alternative Minimum Tax has been repealed.
- Wind and solar credits remain in place.
- The corporate income tax rate has been changed to a flat rate of 21%, which means that if you were taxed as a C corp, and were in the 15% bracket, your corporate tax rate just increased by 6%.
- Like-kind exchange treatment is no longer available for personal property (cattle, equipment, for example). It is still available for real estate. This means that if you exchange personal property, it will be a taxable event, even if no cash changes hands. For most, the changes to Section 179, and the bonus depreciation will be able to absorb this additional tax liability.
- Bonus depreciation phases out. After 2022, it phases out 20% per year, down to 0% bonus depreciation for purchases after 2026.
- If you are depending on government programs for future retirement income, lowering your self-employment tax now will also lower the amount you receive in future retirement income from the government. I know, I know, don’t laugh. I just had to mention that this is a result of taking advantage of expensing and bonus depreciation incentives.
- Section 199A 20% QBI deduction goes away at the end of 2025. There are other limitations which will not usually limit most ranchers, but may limit the ability to include certain income streams as QBI.
- There are some gaps in the law and regulations regarding property qualifying for bonus depreciation. As with most new laws, these kinks will have to get worked out, and soon. Most of the uncertainty surrounds improvements to leaseholds. Typical equipment-type purchases should qualify. For other types, check back for updates.
- There is a glaring gap in the treatment of sales to Co-ops as opposed to sales to independent buyers, making sales to Co-ops considerably more attractive. This is actively being addressed, but the solution is still pending.
Please do not attempt self-service when it comes to tax planning. This area of the law is a minefield, and generally well worth the expense of paying for a knowledgeable guide. Congress is notoriously fickle, so it is advisable to take advantage of the new laws while they are in effect. As widely divergent as the policy goals of our nation’s leaders are, it is not realistic to expect stability in tax law beyond the next election cycle. Contact your tax adviser to discuss which, if any, of these strategies will work for you. The long-term success of your ranch could be significantly impacted depending upon your proactive steps now.