Producer impacts from the Tax Cuts and Jobs Act

Machinery trade - example 1

1. Farmer Jones trades an old combine for a new one. The dealer allows farmer Jones $200,000 on the trade and farmer Jones pays an additional $250,000 to boot to complete the purchase.

2. Under the old method, farmer Jones does not recognize any gain on the trade. Assuming that the old combine has zero basis, farmer Jones’ basis in the new combine is the $250,000 paid to boot (Figure 4).

Machinery trade (new method under TCAJ) - example 2

1. Same circumstances as the example above. Assuming no basis in the combine to be traded.

2. Farmer Jones will recognize $200,000 of depreciation recapture (reported on Form 4797, Part III).

3. Farmer Jones will pay the full price ($450,000) for the new combine. (Figure 5)

4. Strategy: Farmer Jones has a large Section 179 allowance that could be used and/or bonus depreciation on the purchase of the new combine. Using accelerated depreciation could offset the depreciation recapture from the sale of the traded combine.

5. The State of Minnesota will recognize the like-kind-exchange of the machinery trade described above. If the like-kind-exchange qualified under the old pre-TCJA rules, the taxpayer is required to recognize the LKE on the State of Minnesota return.

Machinery trade under TCAJ - example 3

1. Guy and Barb Wire are trading a tractor purchased in 2013 for a new tractor in 2018. The implement dealer allows Guy and Barb a $100,000 allowance on the traded tractor and the Wires pay a cash price of $225,000 for the new tractor.

2. The relinquished tractor had an original purchase cost of $170,000 and has a remaining tax basis of $41,658. Guy and Barb did not take any section 179 or bonus depreciation on the relinquished asset at the time of purchase.

3. The relinquished tractor is sold on IRS Form 4797 (part III). Guy and Barb’s gain on the sale of the tractor is $58,342 ($100,000 allowance minus remaining basis of $41,658). This gain is depreciation recapture (code Section 1245 gain), which is taxed as ordinary income and is not subject to self-employment tax. See Figure 6 for a copy of Guy and Barb's Federal Form 4797.

4. The gain from the sale of the traded tractor is qualified business income (QBI). More information about QBI is discussed in another section.

QBI is defined as:

• Qualified items for income, gain, deduction and loss with respect to a qualified trade or business of the TP.

• Items are qualified only to the extent that they are connected with the conduct of a trade or business in the U.S.

Items that are excluded from QBI:

• Net capital gain or net capital loss.

• Dividends, income equivalent to a dividend, or payments in lieu of dividends.

• Interest income.

• The excess of gain over loss from commodities transactions other than:

  • Those entered into in the normal course of the trade or business, or

  • With respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business, or supplies regularly used or consumed in the trade or business.

• The excess of foreign currency gains over foreign currency losses.

• Net income from notional principal contracts other than clearly identified hedging transactions that are treated as ordinary.

• Any amount received from an annuity that is not received in connection with the trade or business.

QBI for lease income

Lease income may be eligible for qualified business income deduction (QBI).

• Currently, IRS guidance indicates that in order for lease income to be treated as QBI, the lease arrangement must meet the qualification of a trade or business under IRS Code Section 162.

• Trade or business is not specifically defined in the Internal Revenue Code but rather defers to case law for guidance.

• Under case law, trade or business may be established by involvement with continuity and regularity and where the primary purpose is income/profit.

Please note that QBI for leases is a huge gray area. The author can make a compelling argument that land held for cash rent is classified as “held for investment”, rather than a trade or business.

One part of this argument that is settled is self-rentals.

• A self-rental is an arrangement where an entity such as a C-corporation is paying land rent to the owner of the land.

• The owner of the land also is the owner of the C-corporation.

• The key to this provision is “common control”.

• Rental payments made under a self-rental situation does qualify as QBI [Treasury Regulation 107892-18].

It is recommended for cash land leases to not take the QBI deduction until some additional guidance is issued from either the IRS or the courts.

• Crop share leases and Conservation Reserve Program contracts come much closer to meeting the test of trade or business than a cash lease.

• Please consult with your tax professional on this issue.

20 percent pass-through deduction as specified by CAA

• For taxable years beginning after 12/31/2017 and before 01/01/2026.

• An individual taxpayer may deduct 20 percent of qualified business income from a partnership, S corporation, or sole proprietorship, as well as 20 percent of the aggregate, qualified Real Estate Investment Trust (REIT) dividends, and qualified publicly traded partnership income.

For cooperatives, the new Section 199A deduction is essentially the same thing as the old domestic production activities deduction (DPAD). For cooperatives, the section 199A deduction is the lesser of:

• 9 percent of QPAI (qualified production activities income).

• 9 percent of the taxable income without the QBI deduction.

• 50 percent of the W-2 wages.

The above calculation will be made at the cooperative level.

• The cooperative may elect to use the credit or pass the credit on to the patron.

• If the credit is passed through to the patron, that business activity will be reported on Form 1099-PATR.

• If the farmer receives a pass-through QBI credit from the cooperative, the aforementioned credit is not subject to the taxable income restrictions found under the regular QBI calculation.

• If the farmer receives a pass-through credit from the cooperative, the farmer may report the credit against income on his or her Federal Form 1040.

Basic QBI calculation

A taxpayer’s QBI is the lesser of:

• 20 percent of the qualified business income (QBI), or

• 20 percent of (taxable income less capital gains).

Basic QBI calculation - example 6

The following information is from Farmer Pat’s tax return:

• Taxable income of $81,000.

• Schedule F net of $100,000.

• No capital gains.

Farmer Pat’s QBI deduction is the lesser of:

• 20 percent of taxable income ($81,000 x .2 = $ 16,200)

• 20 percent of QBI ($100,000 x .2 = $20,000)

Pat’s eligible QBI deduction is $16,200.

Basic calculation with capital gain - example 7

This example has the same circumstances as the previous example, except Pat also had a $7,000 net capital gain.

Pat’s QBI deduction is the lesser of:

• 20 percent of (taxable income less capital gains) ((20 percent of ($81,000 minus $7,000) = $14,800).

• 20 percent of QBI ($100,000 x .2 = $20,000)

Pat’s eligible QBI deduction is $14,800.

Transition rule regarding DPAD and QBI calculations for producers with sales to cooperatives

The Consolidated Appropriations Act includes a transition rule for farmers who receive a cooperative payment in 2018 that is attributable to QPAI (qualified production activities income) for which the old DPAD (domestic production activities deduction) deduction was applicable.

• This will include any QPAI attributable to a cooperative tax year beginning before 2018. See Section 101(c)(2).

With the original DPAD gone in 2018, taxpayers were left to wonder how to report such DPAD allocations.

• The law clarifies that such farmers will still be able to take the old DPAD deduction in 2018, as long as it is attributable to QPAI which was allowed to the cooperative for a tax year beginning before 2018.

• No 199A deduction will be allowed for such payments [Appropriations Act Sec. 101(c)(2) Division T].

Impact to farmers

Most cooperatives operate under a fiscal year.

• The transition rule will affect farmers that did business with a cooperative with a tax year that started before 12/31/17 (which will be true in most cases).

• Cooperatives with a tax year beginning before 12/31/17 will still be able to calculate and potentially distribute a DPAD to the cooperative patrons.

• If the farmer receives a DPAD passed through from the cooperative, the farmer will be able to use the DPAD on his or her 2018 income tax return.

The transitional rule excludes from the 199A QBI calculation any sales from the farmer that falls within the co-op’s fiscal year.

• It does not matter whether the cooperative passed the DPAD through to the patrons or retained the DPAD at the cooperative level.

• All farm sales that occurred during the cooperative’s fiscal year will NOT be eligible income for the QBI deduction on the farmer’s 2018 individual return.

Transition rule regarding DPAD and QBI calculations for 2018 - example 8

Farmer Jones sells corn and soybeans to ABC Cooperative.

• ABC Cooperative has a fiscal year that began August 1, 2017, and ended July 31, 2018. Fiscal years will vary by the cooperative.

• Since ABC Cooperative’s fiscal year started before 12/31/17, ABC will be able to calculate and potentially distribute a DPAD credit to its patrons.

• A pass-through DPAD credit will be reported on Form 1099-PATR and the aforementioned DPAD credit will be reported on Farmer Jones’ 2018 individual income tax return.

• Farmer Jones must exclude farm sales made to ABC Cooperative that occurred between January 1 and July 31 (the end of the co-op's fiscal year) from the QBI calculation.

• The only co-op sales that Farmer Jones will be able to use for the 2018 QBI calculation will be sales that occurred after July 31.

• Sales that occurred during the fiscal year of the cooperative that was eligible for DPAD at the cooperative level do not qualify as QBI income.

• It does not matter whether ABC retained or distributed the DPAD credit.

With the passage of the Consolidated Appropriations Act (CAA) the QBI deduction for the farmer changes. The formula for QBI deduction if sales to a cooperative are involved is:

• 20 percent of overall QBI (both co-op and non co-op)

• Reduced by the lesser of:

  • 9 percent of the QBI from the trade or business allocable to the cooperative payments, or

  • 50 percent of the wages allocable to the cooperative payments

NOTE: When taxable income is above certain thresholds (MFJ $415,000/All other filers $207,500), wages paid and qualifying assets come into play for the QBI calculation.

QBI calculation with 100 percent sales to cooperative (no wages) - example 9

Farmer Pat has the following information on the tax return:

• All commodity (grain) sold through cooperative.

• $230,000 per unit retains.

• $20,000 patronage dividend.

• $200,000 expenses – no wages paid.

• $50,000 QBI ($230k + $20k - $200k).

Calculation

• 20 percent x 50k = $10,000

• Reduced by the lesser of:

  • 9 percent x $50k (all sales were to cooperative) = $4,500

  • 50 percent x $0 (zero wages paid by farm) = $0

Pat’s QBI deduction is $10,000 ($10,000 minus zero).

QBI calculation with 100 percent sales to cooperative (with wages) - example 10

Farmer Pat has the following information on the tax return:

• Circumstances for this example are the same as the previous example except Pat paid $25,000 in wages.

Calculation

• 20 percent x 50k = $10,000

• Reduced by the lesser of:

  • 9 percent x $50k (all sales were to cooperative) = $4,500

  • 50 percent x $25,000 = $12,500

Pat’s QBI deduction is $5,500 ($10,000 minus $4,500).

NOTE: The cooperative calculation is still subject to the 20 percent of (taxable income less capital gains) limitations.

NOTE: If the cooperative elects to pass-through the credit calculated at the cooperative level, that pass-through amount will get added to the calculated figure in this example.

QBI calculation with 60 percent sales to cooperative (no wages) - example 11

Farmer Pat has the following information on the tax return:

• 60 percent of commodities (grain) sold through cooperative.

• $230,000 per unit retains.

• $20,000 patronage dividend.

• $200,000 expenses – no wages paid.

• $50,000 QBI ($230k + $20k - $200k).

• 60 percent of overall QBI was allocable to the co-op ($50,000 x .6 = 30,000).

Calculation

• 20 percent x 50k = $10,000

• Reduced by the lesser of:

  • 9 percent x $30k (all sales were to cooperative) = $2,700

  • 50 percent x $0 (zero wages paid by farm) = $0

Pat’s QBI deduction is $10,000 ($10,000 minus zero).

NOTE: If the cooperative elects to pass-through the credit calculated at the cooperative level, that pass-through amount will get added to the calculated figure in this example.

QBI calculation with 60 percent sales to cooperative (with wages) - example 12

Farmer Pat has the following information on the tax return:

• 60 percent of commodities (grain) sold through cooperative.

• $140,000 per unit retains.

• $10,000 patronage dividend.

• $100,000 of non-cooperative sales.

• $200,000 expenses – $25,000 wages paid.

• $50,000 QBI ($140k + $10k + $100k - $200k).

• 60 percent of overall QBI is allocable to the co-op ($50,000 x .6 = $30,000).

• 60 percent of wages is allocable to the co-op ($25,000 x .6 = $15,000).

Calculation

• 20 percent x 50k = $10,000

• Reduced by the lesser of:

  • 9 percent x $30k (portion allocable to the sales to the co-op) = $2,700

  • 50 percent x $15k (wages paid by farm) = $7,500

Pat’s QBI deduction is $7,300 ($10,000 minus $2,700).

• Any crop insurance proceeds you receive need to be included as income on your tax return.

• You generally include that income in the year received.

• Crop insurance includes the crop disaster payments received from the federal government as the result of destruction or damage to crops, or the inability to plant crops because of drought, flood, or any other natural disaster.

You can postpone reporting crop insurance proceeds as income until the year following the year the damage occurred, if you meet all the following conditions:

1. You use the cash method of accounting.

2. You receive the crop insurance proceeds in the same year the crops are damaged.

3. You can show that under normal business practice you would have included income from the damaged crops in any tax year following the year the damage occurred.

Currently, deferral of crop insurance or disaster payments is considered an all or none proposition. This topic can be complicated. Please check with your tax professional.

If you use the cash method of accounting to report your income and expenses, your deduction for prepaid farm expenses in the year you pay for them is limited to 50 percent of the other deductible farm expenses for the year (all Schedule F deductions minus prepaid farm expenses). This limit does not apply if you meet all the exceptions described below:

• Many cash-basis tax filers utilize prepaid expenses at year-end to balance expenses with income.

• This practice also allows farm producers to guarantee delivery and lock-in prices on crop inputs for the following year.

Prepayments must meet the following conditions:

1. Must be for an actual purchase and not a deposit.

2. The prepayment has a business purpose and is not merely for tax avoidance.

3. The prepayment does not result in a material distortion of income, according to The Farmers Tax Guide.

There are a couple of exceptions. The limit on the deduction for prepaid farm expenses does not apply if you are a farmer and either of the following applies:

1. Your prepaid farm expense is more than 50 percent of your other deductible farm expenses because of a change in the business operations caused by unusual circumstances.

2. Your total prepaid farm expense for the preceding three tax years is less than 50 percent of your total other deductible farm expenses for those three years.

The maximum prepaid amount is calculated each year based upon the final figures on the Schedule F.

• Fall-applied fertilizer and lime does get treated differently.

• If fertilizer and lime are purchased late in 2016 and applied before January 1, 2017, the fertilizer and lime expense is not considered a pre-payment for tax purposes and thus is not subject to the 50 percent rule, according to The Farmers Tax Guide. 

Case farm example to show the interaction of business income and QBI

We will go back to the example earlier in the paper where Guy and Barb Wire traded tractors.

Example: trading tractors

1. Guy and Barb Wire are trading a tractor purchased in 2013 for a new tractor in 2018. The implement dealer allows Guy and Barb a $100,000 allowance on the traded tractor and the Wires pay a net cash price of $150,000 for the new tractor.

2. The relinquished tractor had an original purchase cost of $170,000 and has a remaining tax basis of $41,658. Guy and Barb did not take any section 179 or bonus depreciation on the relinquished asset at the time of purchase.

3. The relinquished tractor is sold on IRS Form 4797 (part III). Guy and Barb’s gain on the sale of the tractor is $58,342 ($100,000 allowance minus remaining basis of $ 41,658. This gain is depreciation recapture (code section 1245 gain), which is taxed as ordinary income and is not subject to self-employment tax.

4. Tax planning: Guy and Barb could take section 179 or bonus depreciation on the new tractor in order to offset some or all of the $58,342 gain from the traded tractor. Guy and Barb need to consider the following items:

   1. Taking accelerated depreciation (section 179 and bonus) will lower or take the Schedule F negative for 2018. This results in no SE tax paid and can have a negative impact with respect to disability insurance and retirement benefit.

   2. By taking accelerated depreciation, Guy and Barb are using depreciation that would normally reduce ordinary and self-employment tax. By taking the Schedule F negative, they are buying down cheap money with expensive money.

   3. Taking accelerated depreciation will also lower the qualified business income (QBI) deduction. Please note that in this example, the net schedule F and also the depreciation recapture is QBI income.

   4. If Guy and Barb create negative QBI in 2018, the negative QBI carries forward (similar to a Net Operative Loss) and must be offset by positive QBI in a subsequent year before Guy and Barb will qualify for a QBI deduction.

Case 1

1. This example has the Wires with a schedule F showing a net of $35,000 before any accelerated depreciation.

2. One child (under age 17).

3. Wage income of $30,000 with federal withholding of $3,600.

Case 2

1. This example is the same as example 1, except the Wires took accelerated depreciation on the new tractor to the degree that the Schedule F shows a negative $40,000.

2. This lowers the tax due.

3. This practice also significantly lowers the qualified business income deduction.

See Figure 8 to get an overview of how the two cases differ.