On Dec. 22, President Donald Trump signed HR 1 into law. This new law implements the most significant changes to our tax code in more than 30 years. This article provides a general overview of provisions that most impact agricultural producers. Most changes went into effect Jan. 1, meaning they will impact tax returns filed in 2019.
Changes impacting individual taxpayers include the following:
Modifying the individual income tax brackets. Most farm businesses are taxed as sole proprietorships, partnerships or S corporations. This means business income is passed through to the owners, who pay taxes based upon individual income tax rates. Beginning in 2018, HR 1 lowers individual income tax rates across the board. The graduated rates that apply to ordinary income are 10%, 12% (down from 15%), 22% (down from 25%), 24% (down from 28%), 32% (down from 33%), 35% and 37% (down from 39.6%). H.R. 1 leaves the maximum rates on net capital gains and qualified dividends unchanged.
Increasing the standard deduction. Taxpayers only itemize deductions if the amount they can deduct on 1040, Schedule A, is more than their standard deduction. HR 1 will significantly decrease the number of taxpayers who itemize. From 2018 through 2025, HR 1 increases the standard deduction from $13,000 to $24,000 for married filing jointly taxpayers and from $6,500 to $12,000 for single taxpayers.
Eliminating the personal exemption. In 2017, taxpayers could generally take a personal exemption of $4,050 for themselves, their spouse and each of their dependents. In conjunction with increasing the standard deduction and lowering individual income tax rates, HR 1 eliminates the personal exemption from 2018 through 2025.
Eliminating many deductions. HR 1 eliminates or modifies a number of individual itemized deductions for tax years 2018 through 2025:
• State and local tax deduction. For tax years 2018 through 2025, HR 1 limits the amount of combined state and local income and property taxes taxpayers can claim as an itemized deduction to $10,000 ($5,000 for married filing separately). Property taxes incurred in a trade or business, however, continue to be fully deductible on a Schedule C, Schedule E or Schedule F.
• Home mortgage interest deduction. HR 1 lowers the home mortgage interest deduction from $1 million ($500,000 married filing separately) to $750,000 ($375,000 married filing separately).
• Charitable contributions. HR 1 generally leaves in place current law regarding deductibility of charitable contributions. With the increase in the standard deduction and the loss of many itemized deductions, however, many charitable contributions will no longer result in a tax deduction. HR 1 does not change the ability of those over 70½ to exclude from income qualified charitable distributions from an IRA. Nor does it impact the ability of farmers to exclude charitable gifts of grain from income.
• Miscellaneous itemized deductions subject to the 2% floor. For tax years 2018 through 2025, HR 1 suspends all miscellaneous itemized deductions subject to the 2% floor, including, for example, unreimbursed employee expenses and investment fees and expenses.
• Medical expenses deduction. HR 1 retains the current itemized deduction for medical expenses exceeding 10% of the taxpayer’s adjusted gross income. For tax years 2017 and 2018, HR 1 decreases this AGI threshold for everyone (not just those 65 and older) to 7.5%.
Increasing the child tax credit and creating a new dependent credit. HR 1 raises the child tax credit from $1,000 to $2,000 per qualifying child for tax years 2018 through 2025. It also provides a $500 credit for dependents who do not qualify for the child tax credit, including those over the age of 16.
Estate, gift and generation skipping tax. HR 1 does not eliminate the estate or gift tax, but it doubles the basic exclusion amount for tax years 2018 through 2025. Consequently, a person can die with $11.2 million of property in 2018 and the estate will owe no tax. Basis adjustment (often a “step up”) continues at death for all estates.
Corporate tax rate. HR 1 permanently lowers the maximum corporate tax rate from 35% to 21%, beginning in 2018. The law also transforms the corporate tax structure from a graduated system to a flat rate for all income. As such, some small C corporations could see an increase in their corporate income tax rate from 15% to 21%. Farmers operating as a C corporation should consult with their tax advisers to understand the impact of the new law on their business.
Lowering tax rates for pass-through business income. From 2018 through 2025, HR 1 allows most individuals receiving income from a pass through business — including a sole proprietorship, an S corporation or a partnership — to take a new “Section 199A” deduction.
These individuals can generally deduct 20% of “qualified business income,” defined as the net amount of income, gain, deduction and loss attributable to a domestic trade or business, from their taxable income. This includes net farm income reported on Schedule F, as well as net cash rental income reported on Schedule E. Qualified business income doesn’t include income from capital gain or dividends. It also doesn’t include reasonable compensation received by an S corporation shareholder or guaranteed payments received by a partner in a partnership. Income from REIT dividends and qualified cooperative dividends (including patronage dividends and per-unit retain allocations) is eligible for the 20% deduction. Specified agricultural or horticultural cooperatives are also generally eligible.
The 199A deduction is generally limited to 50% of W-2 wages paid (like the old DPAD deduction). However, the wages limitation only applies to individuals with taxable income greater than $315,000 (MFJ) or $157,500 for singles. Once these income levels are reached, the limitation is phased in.
Bonus depreciation. HR 1 allows 100% bonus depreciation for five years for qualifying property acquired and placed into service on or after Sept. 27, 2017. The additional first-year depreciation percentage is then reduced, until fully eliminated in 2027. Notably, HR 1 applies bonus depreciation to used property, as well as new property.
Section 179. Beginning in 2018, H.R. 1 expands Section 179 to provide an immediate $1 million deduction (up from $510,000 in 2017) with a $2.5 million phase-out threshold (up from $2.03 million in 2017).
Farm equipment depreciation. Beginning in 2018, farm equipment may be depreciated over a period of five years, instead of seven years.
Business interest limitation. Although HR 1 restricts business interest deductions generally to 30% of adjusted gross income (beginning in 2018), those restrictions do not apply to businesses with revenue below $25 million.
Net operating losses. Beginning in 2018, HR 1 reduces the five-year carryback of net operating losses for a farming business to two years. It also limits the net operating loss deduction to 80% of taxable income for losses incurred after Dec. 31, 2017.
Like-kind exchange. HR 1 retains IRC §1031 like-kind exchange treatment for real property, but eliminates it for personal property, such as farm equipment or breeding heifers.
Domestic production activities deduction. HR 1 eliminates the DPAD deduction, which has been frequently used by agricultural producers and cooperatives, beginning in 2018.
Farmers should work with their tax advisers to see if they should make changes to their business structures or operations in response to the new law. Taxation is highly dependent upon a taxpayer’s individual set of facts. In general, however, most agricultural producers should see lower tax liability for the next eight years because of HR 1. After that, however, the changes sunset, meaning they go away, unless a future Congress acts to restore them. For more detailed information on the new law, visit calt.iastaste.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].