The Tax Cuts and Jobs Act (the Act) was signed into law on December 22, 2017. This legislation is the most comprehensive tax reform since the 1986 Tax Act. The impact of some provisions contained could be significant for farmers.
Signature elements of the Act included a reduction in the corporate tax rate from 35% to 21%. Additionally, the Act creates a corresponding tax benefit for passthrough entities. The qualified business income deduction gives owners of S corporations, partnerships, and sole proprietors (including Schedule F farmers) a deduction up to 20% of qualified business income.
Qualified income from all activities is aggregated on the taxpayers’ 1040 and should show up as one number on the final return. The conference committee report suggests that if a taxpayer has multiple businesses, the tests discussed below will be applied to each business separately.
To claim deduction, taxpayers must first determine the sum of the following two items:
- The lesser of:
- The taxpayer’s “combined qualified business income amount” (defined below), or
- 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the sum of the taxpayer’s net capital gain and the taxpayer’s aggregate qualified cooperative dividends; plus
- The lesser of:
- 20% of the taxpayer’s aggregate qualified cooperative dividends, or
- The taxpayer’s taxable income minus the taxpayer’s net capital gain.
A taxpayer’s “combined qualified business income amount” for a tax year is generally the lesser of:
- 20% of the taxpayer’s qualified items of income, gain, deductions, and loss relating to any qualified trade or business of the taxpayer, or
- A “W-2 wages/qualified property limit,” which is the greater of:
- 50% of the W-2 wages with respect to the qualified trade or business, or
- The sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the un-adjusted basis immediately after acquisition of all qualified property of the trade or business.
The W-2 wages/qualified property limit described above does not apply if the taxpayer’s taxable income for the tax year is equal to or less than a $157,500 threshold amount ($315,000 for a joint return). If a taxpayer’s taxable income exceeds this threshold, additional limitations apply. Some taxpayers might consider filling separate returns, though further IRS guidance might prohibit this strategy.
The Act provides cooperative patrons whose taxable income has not exceeded the thresholds discussed above, with a simpler and potentially larger deduction. The deduction calculated by multiplying all payments from a cooperative times 20%, limited to the lesser of taxable minus capital gains. This provision has generated significant attention because of the potential unintentional impact to non-cooperative grain elevators. Representatives for Senator John Thune (R) from South Dakota, co-sponsor of the amendment benefiting cooperatives, indicated recently that lawmakers are already examining solutions to “potential unintended effects” of the Act.
Using some basic numbers, let’s take a look at what this all could mean for a Schedule F farmer filing a joint return:
|FACTS||SCENARIO 1||SCENARIO 2||SCENARIO 3|
|Married Filing Jointly|
Sch F Net Income
|Sales to Cooperative (MUST BE A PATRON)||$1,500,000.00||–||$10,000.00|
|Net Capital Gain||–||–||–|
|Allowed Section 199A Deduction||$300,000.00||$60,000.00||$60,000.00|
Note: If the taxpayers taxable income exceeds the taxable income limitations discussed above, then the calculation changes.
The above example illustrates a potential advantage of selling grain by cooperative patrons and the majority (if not all) of your sales are to that type of entity. As is shown in Scenario 1, it is quite possible to zero out taxable income in a given year if Per Unit Retains from a cooperative are large enough. Although there are a lot of moving parts to this, farmers are going to have much more flexibility in determining what they want their taxable income numbers to look like, and this discussion does not consider the increased section 179 and bonus depreciation that may be available. Planning will be essential to maximize the benefits of this provision. On the elevator side of things this obviously creates an advantage to cooperatives that many of their competitors will have to navigate.
Congress anticipated potential attempts to manipulate the qualified business income calculation and has directed Treasury to prescribe regulations that are necessary to carry out the purposes of the Act. Further, the Act appears to lower the standards for assessing a penalty for substantial understatement of tax from a 10% standard to 5%, designed to curb abuse.
Our example has been based upon our interpretation of Section 199A. We have not seen any official guidance from the IRS. We expect that IRS may issue administrative notices designed to provide some interim guidance and solicit comments from taxpayers and their advisors. Regulations in temporary or proposed format could take months or years. This example could change and it could be material. There has already been talk of technical corrections acts, however this will require 60 votes, thus will require bipartisan support.
Bottom line: these provisions are very complicated. Planning is more important than ever before. Contact your local Sikich advisor to discuss your specific situation.