Farm Horizons, Aug. 2018
What the 2017 Tax Cuts, Jobs Act mean to you
By Myron Oftedahl
President Trump signed the Tax Cuts and Jobs Act into law Dec. 22, 2017. What does this mean for you?
There have been a few articles written, but there seems to be a lot of uncertainty regarding the new tax changes.
How the IRS will interpret the language, and what the new forms will look like are a couple concerns.
I will try to give you an explanation of some of the changes; if you need more explanation, contact your tax professional.
The first part of this article will be true whether you are a farmer or not. Generally, the Tax Cuts and Jobs Act lowered the tax rates on each tax bracket, and changed the income levels for the higher brackets.
So, if you had a joint income of $83,000 under the 2017 brackets, you were in a 28 percent bracket that maxed at $93,700. The 2018 bracket maxes at $82,500 with a 24 percent rate. The additional $500 would move to the next bracket, which is taxed at a 32 percent rate.
The standard deduction and personal exemptions are different also.
For 2018, the standard deduction for a married couple filing jointly will be $24,000, and $12,000 for single taxpayers.
The personal exemption of $4,050 per dependent is gone. However, the child/dependent tax credit has been increased from $1,000 to $2,000 per child. Of this $2,000 credit, only $1,400 is refundable. This credit is phased out when the total income is above $400,000. The child/dependent credit also now includes a credit of $500 if you are providing care to other qualifying dependents (elderly parents).
In 2017, a family of five would have had a standard deduction of $12,700 (married, filing jointly), plus an exemption of $20,250 ($4,050 times 5), plus a child tax credit of $1,000 per child under 16.
For 2018, the standard deduction will be $24,000 (married, filing jointly) and a child tax credit of $6,000.
At first glance, it looks like a family of five would be better off under the 2017 rules. However, keep in mind that the child tax credit is a tax credit, and will be deducted from the tax amount due. You will need to compare your own situation in order to have an accurate comparison.
In my example, this family would have a federal tax amount due of $3,575, assuming standard deductions for 2017. Using the same example for 2018, I calculate a federal tax due of $1,967, for a potential tax savings of $1,608.
It will be more difficult to file itemized deductions under the new tax rules. The combined limit for state and local income and property taxes will be $10,000; the deduction for home equity loans is eliminated; unreimbursed employee expenses, including home office expenses, uniforms, license fees, tax preparation fees, safe deposit box rental, and investment fees can no longer be deducted; for 2018, you will be able to deduct medical expenses if they exceed 7.5 percent of your adjusted gross income. In 2019, it reverts back to 10 percent.
If the property tax is for a business, then it will still be reported on Schedule C for a business, or Schedule F for a farm, and will be fully-deductible, regardless of the amount.
You may now gift up to $15,000 per person per recipient without having to file any extra forms or gift tax. So, Mom and Dad could each gift up to $15,000 per child if they wanted to/could afford to.
So, in our family of five, Mom could gift $15,000 to each child, for a total of $45,000; and Dad could do the same thing. This works well when you start looking at a transition process or an estate plan and you start moving assets to the kids. Keep in mind that any gifting will need to meet the five-year lookback period for Medicaid assistance for a nursing home.
The Federal Estate Tax exemption is now at $11,180,000 per person, and this amount is transferable to the spouse, and still retains the stepped-up basis provisions as before.
Let’s say this family of five had a total estate of $15,000,000. One of the parents dies, uses $10,000,000 estate exemption and passes the remaining $5,000,000 to the spouse. The spouse dies five years later with an estate now worth $8,000,000, which would fall under the remaining $12,360,000 exemption ($11,180,000 plus $1,180,000). Also, the real estate assets would receive the stepped-up basis upon each death.
In other words, if the couple paid $500 an acre for the farm, it would become $5,500 per acre on the first death and maybe $6,000 per acre on the second death.
This is why we would typically want the real estate to pass through the estate and not have the children buy it from the parents. If one of the kids were to purchase the real estate from Mom and Dad for $5,500, then Mom and Dad would have to pay capital gains tax on $5,000 per acre. If it passes through the estate, no one pays any tax.
So far, that was the simple part. If you are running a small business or a farming operation where you trade equipment and use depreciation, things just got more complicated.
First of all, the like kind exchange rules apply only to real estate under the new rules. You traded in a tractor for a new tractor. Under the old rules, you added the boot price to the value remaining on the old tractor and depreciated that amount. Now, you will report the trade-in value as income. The total purchase price for the new tractor will be the amount to calculate depreciation on.
For example, the purchase price is $100,000 for the new tractor and you are allowed $55,000 for the old tractor, which had $25,000 remaining value on the depreciation schedule. The old rules would use $80,000 for the new depreciation schedule with no additional income. Now, you will report the $55,000 as income and depreciate the full $100,000 for the new tractor.
The new rule also did two things to help this situation; it allows bonus depreciation to be taken on new and used machinery. Bonus depreciation was allowed only on new machinery prior to this.
The new law also increased the Section 179 depreciation to $1 million. You still need to connect depreciation to the loan if you have taken a loan to purchase the new piece of machinery.
So, in the above example, I could use up to $55,000 for Section 179 in order to offset the trade-in value that I now have to claim as income, and then I would still have $45,000 to depreciate normally. Machinery used to be depreciated for seven years, using the 150 percent declining balance method.
Now, any new machinery can be depreciated over five years using a 200 percent declining balance. My depreciation for the first year would be $9,000. If I financed the $45,000, my payment would be $10,414. When using the 200 percent declining balance, your depreciation amount will vary from year-to-year, and as the title implies, it will be a declining amount each year.
You need to keep depreciation in line with your payments or you could put yourself in a cash bind, making principal payments and not having any depreciation to offset the payments.
Using an excessive amount of Section 179 depreciation could lower your taxable income, which in turn, will lower the self-employment tax. However, this may affect your Social Security retirement benefits when you are ready to retire, because you have not paid as much self-employment tax into Social Security.
Farms will be restricted to deducting only half of the meals that are provided for the convenience of the employer. If you provided meals to the hired help during spring planting or fall harvest seasons, you used to deduct the full amount of those meals. Under the new rules, we can only deduct half of the cost of those meals.
There are some other provisions that apply to farms that are operating under a C corporation, but those can be covered on an individual basis.
The other major provision is the Section 199a deduction, which replaces the DPAD deduction. This is the provision that got a lot of attention early in 2018, as it originally allowed for a 20 percent deduction for sales made to a cooperative and did not include any deduction for non-cooperative sales. This was corrected in March, but requires separate calculations for cooperative and non-cooperative sales. This provision is rather complicated, and could be an article by itself. At this point, keep your sales separate for cooperatives and non-cooperatives in your bookkeeping.
The Tax Cut and Jobs Act appears to have given us some tax relief, although I have seen a few examples resulting in higher taxes due. The final result if you will see a tax savings or not will depend on your tax return. It will not be possible to make a blanket statement saying that all tax filers will have a tax savings for 2018. The new law definitely did not simplify things, as far as income/expense records and tax filings are concerned. Ask your tax preparer for any clarifications that pertain to your farming operation, and be prepared to hear that we don’t know the answer yet.
I know that this topic can be confusing, but I hope that I have given you some insight as to what the changes will be for 2018 and beyond.
All of these changes are in effect through 2025, and then revert back to the old rules, unless Congress acts upon it. I would urge you to talk with a farm management instructor or your tax preparer if you have questions.