Most federal tax reform changes signed into law under H.R. 1 went into effect Jan. 1, 2018, meaning they will impact tax returns filed in 2019. However, dairy farmers need to understand how the law is impacting them early in 2018 so they can make good business decisions and plan accordingly in the months ahead.

In this column, we provide a summary of major changes implemented by the new law and how they impact agricultural producers. In future columns, we will provide more details on some of the more complex, yet important, provisions – like the new 20 percent deduction for “qualified business income.”

Modifying 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, H.R. 1 lowers individual income tax rates across the board.

The graduated rates that apply to ordinary income are 10 percent, 12 percent (down from 15 percent), 22 percent (down from 25 percent), 24 percent (down from 28 percent), 32 percent (down from 33 percent), 35 percent and 37 percent (down from 39.6 percent). 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. H.R. 1 will significantly decrease the number of taxpayers who itemize. From 2018 through 2025, H.R. 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 dependants. In conjunction with increasing the standard deduction and lowering individual income tax rates, H.R. 1 eliminates the personal exemption from 2018 through 2025.

Eliminating many deductions

H.R. 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, H.R. 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.
  
  
• Charitable contributions. H.R. 1 generally leaves in place current law regarding the deductibility of charitable contributions. With many fewer taxpayers itemizing deductions, however, many charitable contributions will no longer result in a tax benefit. H.R. 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.
  
  
• Home mortgage interest deduction. H.R. 1 lowers the home mortgage interest deduction from $1 million ($500,000 married filing separately) to $750,000 ($375,000 married filing separately).
  
  
• Miscellaneous itemized deductions subject to the 2 percent floor. For tax years 2018 through 2025, H.R. 1 suspends all miscellaneous itemized deductions subject to the 2 percent floor, including, for example, unreimbursed employee expenses and investment fees and expenses.
  
  
• Medical expenses deduction. H.R. 1 retains the current itemized deduction for medical expenses exceeding 10 percent of the taxpayer’s adjusted gross income. For tax years 2017 and 2018, H.R. 1 decreases this adjusted gross income threshold for everyone (not just those 65 and older) to 7.5 percent.

Increasing the child tax credit and creating a new dependant credit

H.R. 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 dependants who do not qualify for the child tax credit, including those over the age of 16.

Estate, gift and generation-skipping tax

H.R. 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

H.R. 1 permanently lowers the maximum corporate tax rate from 35 percent to 21 percent, beginning in 2018. Because the law transforms the corporate tax structure to a flat rate for all income, some small C corporations could see an increase in their corporate income tax rate from 15 percent to 21 percent. Farmers operating as a C corporation should consult with their tax advisers to understand the impact of the new law on their business.

Creating a new deduction for pass-through business income

From 2018 through 2025, H.R. 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 percent 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. Qualified business income does not include income from capital gains or dividends.

It also does not include reasonable compensation received by an S corporation shareholder or guaranteed payments received by a partner in a partnership. Income from qualified cooperative dividends (including patronage dividends and per-unit retain allocations) is eligible for the 20 percent deduction. Specified agricultural or horticultural cooperatives are also generally eligible.

The 199A deduction is generally limited to 50 percent of W-2 wages paid; however, the phased-in wages limitation only applies to individuals with taxable income greater than $315,000 (married filing jointly) or $157,500 for singles.

Bonus depreciation

H.R. 1 allows 100 percent bonus depreciation for five years for qualifying property acquired and placed into service on or after Sept. 27, 2017. H.R. 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, new farm equipment may be depreciated over a period of five years instead of seven.

Business interest limitation

Although H.R. 1 restricts business interest deductions generally to 30 percent of adjusted gross income, those restrictions do not apply to businesses with revenue below $25 million.

Net operating losses

H.R. 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 percent of taxable income for losses incurred after Dec. 31, 2017.

Like-kind exchange

H.R. 1 retains Internal Revenue Code §1031 like-kind exchange treatment for real property but eliminates it for personal property, such as farm equipment.

Domestic production activities deduction (DPAD)

H.R. 1 eliminates the DPAD deduction, which is frequently used by agricultural producers and cooperatives.

What’s ahead?

Farmers should work with their tax advisers to see if they should make changes to their business 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 H.R. 1.

After that, most changes will expire unless a future Congress acts to restore them.  

Kristine Tidgren is an assistant director at Iowa State University Center for Agricultural Law and Taxation. Email Kristine Tidgren.