The Tax Cuts and Jobs Act (the “New Tax Law”) provides a special temporary exception to the UNICAP rules for certain costs of replanting citrus plants lost by reason of casualty. The result is that a 100% deduction will be permitted for replacing damaged trees in the first year, rather than having to depreciate the cost over 14 years.
Code Section 263A(d)(2)(C) generally requires the agricultural producer to own the plants at the time that the damage occurred, and to replace them with the same type of crop on property located in the U.S. Further, replanting costs for this purpose generally include costs attributable to the replanting, cultivating, maintaining, and developing of the plants that were lost or damaged, but not the acquisition costs of replacement trees or seedlings (which thus must still be capitalized).
In addition to the above relief for citrus growers, Patricia Wolfe, the American Farm Bureau’s senior director of congressional relations, is quoted as saying, “[a]bout 94 percent of all farms and ranches are organized as pass-through businesses … [t]hat, along with lower rates, should produce a tax reduction for most farmers and ranchers.”
Below are brief highlights of the mechanisms which may impact and benefit the agricultural industry.
Individual Income Tax Rates
The majority of farmers and growers operate via pass-through entities, and as such, income from farming is typically subject to the federal individual income tax rates. The New Tax Law imposes a new tax rate structure with seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37%, and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly.
The federal corporate tax rate will be reduced from 35% to 21% should certain agricultural entities be operating or taxed as a C corporation.
Under the previous tax code, farm corporations and farm partnerships with a corporate partner could only use the cash method of accounting if their gross receipts did not exceed $1 million in any year. An exception allowed certain family farm corporations to qualify if the corporation’s gross receipts did not exceed $25 million.
For tax years beginning after December 31, 2017, the cash method may be used by farmers and growers that satisfy a $25 million gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. Under the gross receipts test, taxpayers with annual average gross receipts that do not exceed $25 million for the three prior tax years are allowed to use the cash method.
This is important because farmers and growers have huge input costs, but factors such as weather, markets, and plant disease can cause their incomes to vary greatly from year to year. Cash accounting can help farmers and growers match income with expenses over the course of yearly swings.
Under the previous version of the tax code, taxpayers were generally allowed to deduct in the year that an asset was placed in service 50% of the cost of the newest tangible property.
For property placed in service and acquired after September 27, 2017, the New tax Law has raised the 50% rate to 100%. Moreover, property eligible for bonus depreciation can be new or used.
Thus, under the New Tax Law, farmers are able to write off 100% of “qualified property” purchased after September 27, 2017, through 2022 (at which point expensing rate begins to be phased down). However, it is important to note that many states do not conform to the federal bonus and 179 depreciation provisions (i.e. the state deduction may incorporate depreciation of assets over their normal recovery lives and methods).
Code Section 179 Expensing
Under the prior tax code, most smaller taxpayers could elect, on an asset-by-asset basis, to immediately deduct the entire cost of section 179 property up to an annual limit of $500,000 (adjusted for inflation).
Under the New Tax Law, the annual maximum amount a taxpayer may expense is increased to $1 million dollars (adjusted for inflation tax years beginning after 2018). The annual limitation amount is reduced by one dollar for every dollar that the cost of all section 179 property placed in service by the taxpayer during the tax year exceeds $2.5 million dollars (adjusted for inflation tax years beginning after 2018).
As such, farmers will be allowed to immediately write-off capital purchases, which can include breeding livestock, farm equipment and single-purpose structures (up to the annual limitation amount).
For items placed in service after 2017, the New Tax Law shortens the depreciation period for any farming equipment or machinery (other than any grain bin, cotton ginning asset, fence, or another land improvement) from seven years to five years.
Additionally, many types of farm property will be depreciated under the 200% (instead of 150%) declining balance method. More specifically, a farming property is depreciated under the 200% declining balance method, except for:
- buildings and trees or vines bearing fruits or nuts (to which the straight-line method applies);
- property for which the taxpayer elects either the straight-line method or 150% declining balance method;
- 15- or 20-year MACRS property that has to be depreciated under the 150% declining balance method; and
- property subject to the ADS.
Land improvements other than buildings are 15-year property, and fences and grain bins have a 7-year recovery period, and single-purpose agricultural or horticultural structures (e.g., greenhouses, specialized housing for livestock) have a 10-year recovery period.
Starting in 2018, taxpayers are allowed a deduction equal to 20 percent of “qualified business income,” which includes income from partnerships, S corporations, LLCs, and sole proprietorships. The income must be from a trade or business within the U.S. Investment income does not qualify; nor does amounts received from an S corporation as reasonable compensation or from a partnership as a guaranteed payment for services provided to the trade or business. The deduction is not used in computing adjusted gross income, just taxable income.
For taxpayers with taxable income above a certain threshold ($157,500 for single filers and $315,000 for joint filers):
- a limitation based on W-2 wages paid by the business and depreciable tangible property used in the business is phased in; and
- income from specified service businesses is phased out from being classified as qualified business income (businesses in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners).
The new provision allows farmers to deduct up to 20% of their total sales to cooperatives, which can result in some farmers reducing their taxable income to zero. It is a more generous version of the above-mentioned that owners of pass-through businesses get. Conversely, farmers get a smaller deduction, 20% of gross income, if they sell grain or other farm products to privately held or investor-owned companies.
Example: Company A, a wheat farmer, has $500,000 in annual grain sales and $80,000 in profit. If the farmer sells grain to a cooperative, it could deduct 20% of sales, effectively eliminating its entire income-tax liability. Alternatively, if the farmer sells grain to an independent grain operator, the farmer’s deduction would be limited to 20% of the profit (i.e. $16,000), resulting in taxable income of $64,000 in taxable.
Farm cooperatives are organizations owned by groups of farmers and ranchers who market their crops
A “specified agricultural or horticultural cooperative” means an organization which is engaged in:
(a) the manufacturing, production, growth, or extraction in whole or significant part of any agricultural or horticultural product;
(b) the marketing of agricultural or horticultural products which its patrons have so manufactured, produced, grown, or extracted, or
(c) the provision of supplies, equipment, or services to farmers or to organizations.
30% Interest Limitation
The New Tax Law replaces earnings stripping rules with a limitation on the deduction of business interest. Under this limitation, the deduction allowed for business interest for any tax year cannot exceed the sum of:
- the taxpayer’s business interest income for the tax year;
- 30% of the taxpayer’s adjusted taxable income for the tax year; plus
- the taxpayer’s floor plan financing interest for the tax year.
The business interest limitation does not apply to a taxpayer that meets the $25 million gross receipts test (average annual gross receipts for the three-tax-year period ending with the prior tax year do not exceed $25 million).
Thus, farmers and growers will be limited on deducting interest expenses when their taxable income exceeds $25 million.
A farming business can elect out of the definition of “trade or business” for purposes of applying the interest imitation (thus, the limitation would not apply). However, a slower depreciation method would then have to be used on certain farm property with recovery periods of 10 years or more.
For federal purposes, citrus trees and other crops are considered Code Section 1245 property, so there are issues in doing like-kind exchanges; under state law, they are considered real property. Like-kind exchanges remain a planning opportunity with respect to real property, but if you have agricultural crops or citrus trees on such property, please discuss with your tax adviser.