Impact on Farm Country in the Senate Finance Committee Draft Tax Reform
By Denise Bode
In a nine hundred-page draft, Chairman Dave Camp proposes the most sweeping reform of the tax code since President Reagan proposed one 30 years ago. This is dead on arrival this year, particularly since Camp's partner in the Senate Finance Committee, Chairman Max Baucus has moved on to be replaced by Senator Ron Wyden whose top priority is the business extenders bill not tax reform. However what is true, is that serious drafts like this can provide a basis for future starting points on legislation and individual revenue raisers that can be snatched as "pay-fors" on other bills in the interim. Captured below are issues of top importance for farm country, and a summary of other items in the bill.
Here are some beneficial changes for farmers:
-179 expensing would be made permanent at the 2008-2009 levels. Taxpayers would be able to expense up to $250,000 of investments in new equipment and property per year, with the deduction phased out for investments exceeding $800,000 (with both amounts indexed for inflation). The provision would also restore and make permanent rules allowing computer software and certain investments in real property to qualify for section 179 expensing. In addition, the provision would allow investments in air conditioning and heating units to qualify for section 179 expensing. The provision would be effective for tax years beginning after 2013.
Corporate tax rate reduced to 25% by 2019. Under the provision, the corporate tax rate would be a flat 25-percent rate beginning in 2019. A transition rule would set the rate for taxable income up to $75,000 to 25 percent beginning in 2015, with the rate on income above that level phased down to 25 percent as follows:For tax years beginning during calendar year: 2015--33%;2016-31%; 2017-29%; 2018-27%; 2019 and later-25%.
Here is a list of changes that should concern agriculture:
-Cash Accounting--businesses with average annual gross receipts of $10 million or less may use the cash method of accounting; whereas businesses with more than $10 million would be required to use accrual accounting. The provision would not apply to farming businesses, which would continue to be subject to current-law accounting rules. Sole proprietors also would continue to be able to use the cash method regardless of the level of gross receipts. The provision would be effective for tax years beginning after 2014. A taxpayer generally would be permitted to include any positive adjustments to income resulting from the provision over a four-year period beginning with its first tax year after 2018 in the following amounts: 10 percent included in the first year (2019); 15 percent in the second year (2020); 25 percent in the third year (2021); and 50 percent in the fourth year (2022). At the election of the taxpayer, the four-year inclusion of the adjustment could begin prior to 2019.
-Repeal of income averaging for farmers Under current law, an individual engaged in certain farming or fishing businesses may elect to compute his current year tax liability by averaging, over the prior three-year period, all or a portion of his taxable income from the trade or business of farming or fishing. Under the provision, the farm income-averaging method would be repealed. The provision would be effective for tax years beginning after 2014.
-Repeal of deductions for soil and water conservation expenditures and endangered species recovery expenditures.
-Like kind exchanges would be repealed. The provision would be effective for transfers after 2014. However, a like-kind exchange would be permitted if a written binding contract is entered into on or before December 31, 2014, and the exchange under the contract is completed before January 1, 2017.
-Depreciation recapture with respect to depreciable real property are revised to limit the amount treated as ordinary income to the lesser of: (1) the difference between the accelerated depreciation and straight-line depreciation attributable to periods before 2015, plus the total amount of depreciation attributable to periods after 2014, or (2) the excess of the amount realized over the adjusted basis. The provision would be effective for dispositions after 2014.
-The maximum amount that can be depreciated for personal-use automobiles is $45,000 over 5 years.
-Repeal of the automatic deduction for fertilizer costs under Section 180, Percentage depletion is repealed(important for farmers who are oil and gas royalty owners), Half of advertising expenses are allowed in year one, remainder is amortized over 5 years, Amortization of most intangible assets are now over 20 years instead of 15 year, Elimination of current depreciation and reexamination of asset classes likely to reduce depreciation deductions. The provision would require the Treasury Department, in consultation with the Bureau of Economic Analysis, to develop a new schedule of economic depreciation, and submit a report to Congress containing the new schedule and other recommendations by December 31, 2017. Of critical importance to farmers is that it requires them to reexamine all the class lives of depreciable assets, focusing on the economic life of the assets, and has them revise the IRS guidance to taxpayers. Such an update has not been published since 1987, and the nature of asset classes has changed dramatically in the last 26 years. Since this is a big revenue raiser, it has to be contemplated that your depreciation deductions are likely to be significantly impacted.
Tax Rates required for Pass-Through Businesses like LLCs to 35 percent, 25 Percent for Those Engaged in Manufacturing
- More than 50 percent of business income is taxed through the individual income tax code. As a result, these "pass-through" businesses face top marginal tax rates as high as 39.6 percent on their income.
- However, domestic manufacturing pass-through income will be exempt from the 10 percent "surtax" on incomes over $400,000, meaning this income would only face a lower 25 percent rate.
- Repeal of Last-in, First-out Accounting. Businesses are currently allowed to choose one of two ways to account for the cost of inventory: Last-in, First-out (LIFO) and First-in, First-out (FIFO).
- The proposal would repeal LIFO accounting. Existing corporate LIFO reserve would be added back into taxable income in four phases between 2018 and 2020, retroactively taxing this inventory.
- Change in Test for Independent Contractors Under current law, the determination of whether a worker is an employee or an independent contractor is generally made using a 20-factor common law test to determine whether the worker is subject to the control of the service recipient, not only as to the nature of the work performed, but also as to the circumstances under which it is performed unless current law specifically classifies a worker as an employee such as real estate agents and direct sellers. Under a special safe harbor rule (section 530 of the Revenue Act of 1978), a service recipient may treat a worker as an independent contractor for employment tax purposes, even though the worker may be an employee, if the service recipient has a reasonable basis for treating the worker as an independent contractor and certain other requirements are met.
- This new test for classifying independent contractors would establish a safe harbor test that would allow some workers to not be considered an employee and the service recipient would not be treated as the employer for any Federal tax purpose. The safe harbor also would apply to three-party arrangements in which a payor other than the service recipient pays the worker.
- To qualify for the safe harbor, the worker would have to satisfy certain sales or service criteria and the worker and service recipient would be required to have a written agreement meeting specified requirements. In addition, the service recipient would withhold tax on the first $10,000 of payments made to the worker in a year at a rate of 5 percent
- In any case in which the IRS determines that the requirements of the safe harbor were not satisfied, the provision generally would limit the IRS to reclassification of the worker as an employee and service provider as an employer on a prospective basis. To avoid retroactive reclassification, the worker or service provider would have to have satisfied the written agreement and the reporting and withholding requirements of the safe harbor and have had a reasonable basis for claiming that the safe harbor applied.
- The rationale is that now small business faces uncertainty under the current test and this will prevent the IRS reclassifying a worker as an employee resulting in additional taxes to be paid retroactively. My quick read of this new classification of workers is that it is quite detailed and burdensome and the safe harbor is not practical in that it requires a written agreement and withholding by service recipient. This will turn the classification of independent contractors upside down adding complexity and burden on both parties. This provision is scored as a loss of revenue so the staff must intend this to be helpful, but not clear.
Elimination of Many Energy Provisions
- Eliminates percentage depletion-many farmers are royalty owners and utilize this deduction from oil and gas production under their land. Current law allows a 15% deduction of gross royalty income that would eliminated here.
- Eliminates credit for producing oil and gas from marginal wells
- Eliminates enhanced oil recovery credit
- Eliminates deduction for energy efficient commercial buildings
- Eliminates credit for alcohol used as fuel
- Eliminates credit for biodiesel and renewable diesel used as fuel
- Eliminates passive activity exception for working interests in oil and gas property
- Phases-out credit for electricity produced from certain renewable resources
- Eliminates credit for production of low sulfur diesel fuel
- Eliminates credit for production from advanced nuclear power facilities
- Eliminates credit for producing fuel from a nonconventional source
- Eliminates new energy efficient home credit
- Eliminates energy efficient appliance credit
- Eliminates credit for carbon dioxide sequestration
- Eliminates solar energy credit
Other Business Provisions
- Section 199 manufacturing deduction allows businesses to deduct 9 percent of qualifying manufacturing expenses (6 percent for integrated oil and gas companies). This deduction is phased out completely.
- The Research and Development (R&D) tax credit gives businesses a tax credit for research and development expenses. The Proposal will make the R&D credit permanent while modifying how it is calculated.
- Advertising Expenses must be amortized. Under the provision, 50 percent of certain advertising expenses would be currently deductible and 50 percent would be amortized ratably over a ten-year period.
- Disallows businesses from deducting the cost of executive bonuses if they are in stock and imposes a 25 percent excise tax on compensation over $1 million paid by non-profit, tax-exempt organizations.
- Entertainment deduction severely curtailed. Under the provision, no deduction would be allowed for entertainment, amusement or recreation activities, facilities or membership dues relating to such activities or other social purposes. In addition, no deduction would be allowed for transportation fringe benefits or for amenities provided to an employee that are primarily personal in nature and that involve property or services not directly related to the employer's trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee). The 50-percent limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals under the provision, with no deduction allowed for other entertainment expenses. Furthermore, no deduction would be allowed for reimbursed entertainment expenses paid as part of a reimbursement arrangement that involves a tax-indifferent party such as a foreign person or an entity exempt from tax. The provision would be effective for amounts paid or incurred after 2014.
- The ACA 2.3 percent excise tax on medical devices would be repealed.
A Shift to a Territorial System, with a Retroactive Tax on Foreign Earned Income
- Currently, U.S. corporations are taxed on their worldwide income, but allowed to defer taxes on foreign income that remains actively invested abroad. When corporations earn income overseas and bring this income back to the United States, the United States taxes it at 35 percent, minus any foreign taxes paid on the income.
- The Camp proposal would deem accumulated past foreign earnings currently held abroad in cash as repatriated and retroactively tax it once at an 8.75 percent rate. Remaining non-cash accumulated foreign earnings held abroad (income that has already been reinvested in property, plant, and equipment) would be retroactively taxed at a lower 3.5 percent rate. The corporation has the option to pay this tax over an eight year period.
- Going forward, the United States would switch to a territorial corporate tax system, which would exempt from domestic corporate taxation 95 percent of all active foreign income. Look-through rules, which allow corporations to move money between foreign subsidiaries without triggering U.S. tax liability, would be made permanent. Subpart F will be modified so that intangible income (such as royalties) will be taxed at a 15 percent rate, whether it is earned domestically or abroad. This is similar to the "patent boxes" found in other countries. There will also be a "thin-cap" rule that limits deductions for interest expense based on the leverage of the U.S. parent relative to foreign subsidiaries.
New Excise Tax on Big Banks
- The proposal introduces a .035 percent excise tax on banks that are deemed "important." This tax will be levied quarterly on these banks' total consolidated assets in excess of $500 billion beginning in 2015.
Individual Income Taxes
Tax Brackets Consolidated to Three Brackets with a Top Rate of 35 Percent. The plan consolidates the existing seven tax brackets down to three brackets of 10, 25, and 35 percent. The 10 percent rate would apply to individual filers with taxable income below $35,600 and joint filers with income below $71,200. On taxable income above those levels, taxpayers will pay a rate of 25 percent. The individual AMT is eliminated and the brackets remain indexed to inflation, but based on chained CPI.
The additional surtax of 10 percent (the third bracket with a rate of 35 percent) will be levied on certain income based on a modified definition of AGI (MAGI) for individual filers above $400,000 and joint filers above $450,000.
The MAGI measure is adjusted gross income minus charitable contributions and qualified domestic manufacturing income, plus multiple streams of income excluded or deducted from AGI under current law, including employer provided health benefits, the self-employment health deduction, foreign income, tax exempt interest, untaxed social security benefits, and currently excluded 401(k) contributions.
The standard deduction increases to $11,000 for an individual and $22,000 for joint filers. There is also an additional deduction of $5,500 for single taxpayers with at least one qualifying child, which begins to phase out at $30,000 of AGI. It is worth noting that this proposal does not take any steps to eliminate the marriage penalty inherent in the rate structure.
Phase-Outs in Plan Create Additional Marginal Tax Rates
The proposal creates multiple implicit marginal tax rates due to multiple phase-outs and the income surtax. A major change would be the phase out of the 10 percent rate bracket for individual filers with income above $250,000 and joint filers with income above $300,000. In effect, this would phase in a tax claw back, where individual filers who make over $250,000 ($300,000 for joint filers) would face a 25 percent tax rate on all income below the 35 percent bracket on income over $400,000 for single, $450,000 for filing jointly.
The standard deduction and the child tax credit would face a phase-out as well. (Personal exemptions are eliminated, so no need for a phase-out there.) This would create new implicit marginal tax rates for taxpayers as their income increases and these provisions phase out.
The phase out for all of these provisions occur sequentially starting at $250,000 for singles and $300,000 for filing jointly, in this order: (1) the 10 percent bracket, (2) the standard deduction or equivalent amount of itemized deductions, and (3), the child tax credit.
Proposal Makes Significant Changes to Individual Tax Expenditures
Chairman Camp's proposal makes changes to a significant number of individual tax expenditures. The lists below are not all inclusive. For a complete list, see the Ways and Means section by section summary.
- Eliminates the personal exemption
- Eliminates the Pease provision which limits itemized deductions
- Eliminates state and local tax deduction
- Eliminates the alternative minimum tax
- Eliminates deduction of interest on education loans.
- Eliminates adoption tax credit
- Eliminates credit for green energy residential improvements
- Eliminates credits for qualified electric vehicles and alternative motor vehicles
- Eliminates first time homebuyer credit
- Eliminates deduction for tax preparation expenses
- Eliminates deduction for medical expenses
- Eliminates deduction for moving expenses
- Reduces the principal cap for the home mortgage interest deduction from new mortgages from $1 million to $500,000 over four years.
- Reduces the maximum credits for the EITC to $200 for joint filers with no children, $2,400 with filers with one child, and $4,000 for joint filers with two or more children. For taxpayers with children, phase outs begin at $20,000 for single filers and $27,000 for joint filers.
- Converts some excludable 401(k) contributions to Roth-style retirement accounts for those contributing more than $8,750.
- Modifies allowable contributions to Roth IRAs, eliminating the income eligibility limit for contributors and prohibiting contributions to traditional IRAs.
- Consolidates the four higher education tax credits into a reformed American Opportunity Tax Credit. The new credit would provide a 100 percent credit on the first $2,000 of certain education expenses, and a 25 percent credit on the next $2,000 of expenses. The first $1,500 of the credit would be refundable.
Expands the child tax credit from $1,000 per child to $1,500 per child and $500 for non-child dependents. Credits will be indexed to chained CPI.
Increases in the standard deduction to $11,000 for an individual and $22,000 for joint filers, with an additional deduction of $5,500 per qualifying child.
Capital Gains and Dividend Taxes Increase from 23.8 Percent to 24.8 Percent. Under the plan, capital gains and dividends would be taxed at the ordinary rate with a 40 percent exclusion. This means, with a top rate of 35 percent, the top effective rate capital gains and dividend rate would be 21 percent. Add this to the 3.8 percent Affordable Care Act surtax, for a total of 24.8 percent. However, it's likely taxpayers will face higher marginal rates due to the phase out of the standard deduction, child tax credit, and 10 percent bracket.