By Kent Vickre
December can be a stressful time finishing bookwork and your tax plan. With all the changes in the Tax Cuts and Jobs Act for 2018, this is especially true. Here’s an overview of the changes effecting capital purchases and how they may affect your net farm income:
New tax-free exchange or 1031 rules for 2018. Typically, this terminology is used when someone does an exchange on farmland. When producers have traded equipment or “rolled a combine,” it also has been considered a tax-free exchange. However, starting Jan. 1, 2018, a tax-free exchange is only available for real property. This change means any equipment trades (personal property) must be treated as a sale and a purchase.
For example, on Jan. 1, 2018, Joe traded in a tractor with a fair market value of $75,000 on a new tractor and paid a total of $100,000 difference (boot). For 2018, he will need to report the old tractor as a sale of $75,000 and recognize any taxable gain (sale price minus tax basis). Then he will report the purchase of the new tractor valued at $175,000 ($75,000 trade value plus the boot). It’s important to be aware of this change for record keeping and tax planning.
New depreciation life and limit for 2018. This refers to Section 179, quick write-off depreciation for purchased capital assets. For 2018, the Federal 179 deduction limit is $1 million. The 179 election is limited to qualified capital purchases, such as grain bins or breeding livestock, with a dollar-for-dollar phase-out starting at $2.5 million.
For 2018, bonus depreciation is 100% and includes both new and used assets with a 20-year or less recovery. This includes farm machine sheds.
Also for 2018, producers will use the faster 200% declining balance method of depreciation for equipment and the recovery period is shortened to five years (previously seven years).
As discussed above, 2018 has big changes regarding capital asset purchases and depreciation options. The new rules will allow many producers to offset any recognized gain on traded assets and lower their taxable farm income. However, I would like to add several words of caution if you are using depreciation as your only tax management tool.
• Choosing to offset gain on traded equipment with bonus depreciation or a 179 deduction could easily create a negative Schedule F, thus reducing Social Security tax. Paying less Social Security tax now will reduce your retirement income later.
• Just because it is tax-deductible doesn’t mean it will make your business more profitable. Also, be sure to consider the cash flow needed in future years because any principal will need to be paid with “after tax dollars.” For example, if you purchase farm equipment (five-year depreciable property), and finance it over five years, the principal payments needed for cash flow will be close to the depreciation expense. However, if you deduct the entire cost this year, you’ll have no depreciation expense in the following years.
Many more changes will affect your tax returns such as tax rates, credits and section 199A deduction in 2018. Read the November Wallaces Farmer article titled End-of-Year Tax Planning for additional details on these items.
Tax adjustment tools
The good news is that many of the tools producers have typically used to adjust their farm income are still available. Here are some common examples cash basis producers can still use to adjust their farm income in 2018.
Prepay operating inputs. Be sure to specify a quantity and price. Remember, prepaid expenses are limited to 50% of deductible expenses.
Defer crop insurance proceeds. You may elect to defer income to the following year if you meet specific conditions, such as:
• You use the cash method of accounting.
• You receive crop insurance proceeds in the same year that the crops were damaged.
• You can show, under normal business practice, you would have included income from the damaged crops in any tax year following the year the damage occurred.
Also, only crop insurance proceeds paid because of crop damage or the inability to plant crops are eligible for the deferral under Internal Revenue Code 451(d). To clarify, insurance policies that have both a yield and price component such as Revenue Protection (RP) will require a separate calculation. To calculate the deferral amount, you must calculate a percent of physical loss compared to the total loss.
Pay your children a reasonable wage for farm work. You don’t have to pay Social Security tax on your own children under age 18, (entities do not have children). You must file the appropriate payroll tax forms.
Pay any accrued interest. It’s a potential tax saver some farmers overlook.
Consider income averaging. Depending on the prior year’s taxable income, income averaging may decrease your tax liability.
Review CCC loan tax treatment. If you have “sealed grain” carrying over at year-end, simply electing to change the tax treatment may increase or decrease your taxable income. You may need to file additional forms with your return.
Consider or review deferred payment contracts. For maximum flexibility, since the installment sale election is on a contract-by-contract basis, consider multiple smaller contracts, selecting specific contracts to include as income to attain the income goal.
Fund your retirement account. Because some plans need to be set up by Dec. 31, be sure to check into this now. The limits for 2018 for the traditional deductible retirement accounts are:
• Traditional IRA. These are available to any individual under the age of 70½ with earned income. For 2018, the maximum contribution is $5,500 or your earned income (whichever is less). Individuals age 50 or older also can make an additional $1,000 “catch up” contribution; this increases the limit to $6,500. However, be aware of income phase-out limits.
• SEP/Keogh. These retirement plans may permit greater contributions and deductions. The deduction is limited to a percent of net self-employed income minus the self-employment tax deduction for the self-employed individual or a percent of wages for an employee. The maximum level is 20% for a self-employed individual and 25% of wages for an eligible employee with a maximum limit of $55,000.
Keep in mind this article only discusses federal tax issues, your state income tax may be drastically different. Because of these changes and complexity, be sure to review your tax plan with your tax consultant before Dec. 31.
Vickre is state coordinator of the Iowa Farm Business Association. Contact him at [email protected] or 515-233-5802.