On Oct. 26, President Donald Trump signed the Family Farmer Bankruptcy Clarification Act of 2017 into law. This provision is intended to assist struggling farmers by providing them with more options for reorganizing through a Chapter 12 bankruptcy.
Chapter 12 is the bankruptcy provision specially created in 1986 for "family farmers" or "family fishermen." Chapter 12 allows financially distressed farmers to propose and carry out a plan to repay all or part of their debts by making installment payments to creditors over a three- to five-year period. Under such a plan, unsecured debt, or debt not secured with collateral, can be discharged, meaning that it will not be repaid.
The new law supersedes Hall v. U.S., 132 S. Ct. 1882 (2012), a 5-4 U.S. Supreme Court decision that interpreted bankruptcy law to make it nearly impossible for farmers to discharge capital gains tax arising due to sale of property after the filing of a Chapter 12 bankruptcy petition.
Why is new bankruptcy law needed?
In Hall, the Supreme Court declared that taxes incurred due to the sale of farm assets used in the debtor’s farming operation could be treated as unsecured claims only if the sale occurred in the tax year prior to the filing of the bankruptcy petition. This meant that many farmers could not reorganize their operations by selling assets to “right size” the business after the bankruptcy action began. The tax liability could not be discharged, and there was insufficient liquidity to pay the tax. Often, selling assets before the filing was unworkable.
The new law, co-sponsored by Sens. Charles Grassley and Al Franken, makes it clear that tax liability arising because a farmer sells farming assets after filing a Chapter 12 bankruptcy petition, but before discharge, will be dischargeable in the bankruptcy action. Since the Supreme Court decided Hall, Sen. Grassley had made multiple attempts to “fix” what he characterized as Hall’s misinterpretation of original congressional intent. The president's signature on this bill enacted this fix.
This law will make Chapter 12 a better tool for a number of debtors. Still, many are precluded from using Chapter 12 because the debt limit, although adjusted for inflation, has not kept pace with current asset values. It is currently set at $4,153,150. Some farmers just above the limit may be able to file a Chapter 12 by selling assets to reduce some debt before filing.
Tax reform moving forward
In other tax-related news, detailed tax reform proposals were released by the House on Nov. 2. Although the negotiations are ongoing and details are fluid, it’s useful to review some of the early proposals:
• Collapsing the tax brackets. This proposal calls for reducing the current number of tax brackets from seven to four. The new brackets would be set at 12%, 25%, 35% and 39.6%. Although most taxpayers’ income would be subject to lower tax rates under the new brackets, some in the middle would see some income shift from a top rate of 33% to 35%.
• Increasing or eliminating deductions. By increasing the standard deduction and eliminating personal exemptions and most itemized deductions, this proposal aims to “simplify” the tax code by doubling the standard deduction to $24,400 for those who are married filing jointly and to $12,200 for those who are single. In exchange for doubling the standard deduction, the proposal eliminates the personal exemption, which is $4,050 per person in 2017, and eliminates most itemized deductions.
Taxpayers could still itemize if the amount of their charitable contributions, property taxes (up to a $10,000 limit) and home mortgage interest deduction exceeds the amount of the standard deduction. Other itemized deductions, such as those for state and local taxes, medical expenses, and tax preparation fees, would be eliminated. A number of credits, such as the adoption credit and the credit for the elderly and disabled, would also be eliminated.
• Increasing the Child Tax Credit and creating a New Family Credit. To offset the significant impact of the loss of the $4,050 personal exemption per person upon families, the proposal would increase the child tax credit to $1,600. It would also increase the income levels at which the child tax credit begins to phase out. The child tax credit would continue to apply only to children under the age of 17. A new $300 family credit would also be allowed for each spouse and non-child dependent. This family credit would be offered for five years.
Although this proposal has been touted by some as benefiting all middle-class families, some larger families could see a significant tax increase under the proposal. Families with three or more children who have typically itemized deductions could, in particular, see increased tax liability.
The proposal would retain the American Opportunity Tax Credit (and expand it a bit) and the Earned Income Tax Credit. Tax benefits permitted for retirement plans would be largely unchanged.
• Repealing the Estate Tax and the Generation Skipping Tax. The proposal would initially double the basic exclusion allowed for each person. Every person could die with up to $11.2 million in assets in 2018 and owe no estate tax. Portability would continue to allow a deceased spouse’s unused exclusion to be used by the surviving spouse. In other words, if both spouses were to die in 2018, they could exclude up to $22.4 million in property from the estate tax. The estate and generation-skipping tax would be repealed altogether beginning in 2024. The gift tax would remain, although the higher exclusion amounts would apply. Most significantly, the House proposal would retain the current step-up in basis at death for all estates.
• Business provisions. The most significant change in the proposal would be to lower the maximum corporate tax rate from 35% to 20%. Since most small businesses, including farmers, however, operate as sole proprietors or as pass-through entities such as partnerships or S corporations, this provision would not aid them.
The proposal seeks to lower the rate for these businesses from the highest individual rate of 39.6% to 25%. These provisions, however, are anything but simple. The proposal contains complex provisions to ensure that taxpayers can’t shift wage income to business income to take advantage of the new preferential rate. By default, 30% of a typical pass-through business’s income would be considered “qualified business income” entitled to the lower rate. The other 70% would be considered attributable to labor and taxed at ordinary individual income tax rates. Self-employment liability would accrue for income attributed to labor or to those activities in which the taxpayer materially participates. Because of the complexity of this issue, we are likely to see a number of suggested changes to these proposals.
• Bonus depreciation. The proposal calls for five years of 100% bonus depreciation, which would include used, in addition to new property. The Section 179 deduction would also be expanded to $5 million, with a phaseout threshold of $20 million.
The proposal would also retain IRC §1031 like-kind exchange treatment for real property, but eliminate it for personal property, such as farm equipment or breeding heifers. The proposal would eliminate the Domestic Production Activities Deduction (DPAD), which is frequently used by agricultural producers, in 2018.
The proposal would leave intact the current capital gains system, cash accounting (and actually expand it to further businesses), the conservation easement deduction, income averaging and the deduction of business interest for businesses with $25 million or less in revenue.
Remember, these are just proposals. It’s impossible to predict what will happen with tax reform. It’s important, however, for taxpayers to stay up to date on the proposals being discussed in Washington. For current updates, visit calt.iastate.edu.
Tidgren is staff attorney and assistant director for the Center for Ag Law and Taxation at Iowa State University. Contact her at [email protected].