September 2018 Ag Law

__________________________________________________________ CLE CLE CLE CLE CLE __________________________________________________________ The State Bar of South Dakota and the Committee on Continuing Legal Education present

Co-Chairs: Mike Traxinger & Jason Sutton

Friday, September 28, 2018 Harvest Room Ramkota Hotel, Sioux Falls, SD __________________________________________________________ CLE CLE CLE CLE CLE __________________________________________________________

The State Bar of South Dakota, The Committee on Continuing Legal Education and the Agricultural Law Committee Present:

Co-Chairs: Mike Traxinger & Jason Sutton September 28, 2018 Ramkota Hotel, Sioux Falls Harvest room

12:30 – 1 pm

Registration: Free to Active State Bar Members, Others: $100

1:00 – 2:00 pm

The Impact of the Tax Cuts & Jobs Act on Agricultural Producers: Kristine Tidgren – Director, Center for Agricultural Law & Taxation Iowa State University, Ames, IA

2:00 – 2:15 pm

Break

2:15 – 3:15 pm

The Impact of the Tax Cuts & Jobs Act on Agricultural Producers: Kristine Tidgren – Director, Center for Agricultural Law & Taxation Iowa State University, Ames, IA

2:00 – 2:15 pm

Break

3:30 – 4:15 pm

How to Manage the Trenches During the Farm Crisis Steven Huff – Marlow, Woodward & Huff, Yankton Laura Kulm Ask – Gerry & Kulm Ask, Sioux Falls

If you wish to have this program submitted to a mandatory CLE jurisdiction for CLE credit, please see Tracie (tracie.bradford@sdbar.net) or Nicole (nicole.ogan@sdbar.net) at the registration desk or drop them an email.

Kristine Tidgren 1

Kristine is an adjunct assistant professor in the Agricultural Education & Studies Department and the director for the Center for Agricultural Law and Taxation. Kristine’s work focuses on studying and interpreting laws impacting the agricultural industry. In particular, she focuses on agricultural taxation.

Since joining CALT in 2013, Kristine has written hundreds of articles and blogposts to keep tax professionals, practicing attorneys, producers, and agribusiness professionals informed about legal developments impacting their business. She also writes technical chapters for the National Income Tax Workbook and regular articles for farm publications. In addition to her writing, Kristine speaks to many professionals and producers each year regarding tax and agricultural law topics. She also plans and provides instruction for CALT-hosted seminars, including the annual federal income tax schools.

Kristine teaches AgEds 451, a four-credit agricultural law class to upper-level undergraduate students in the College of Agriculture and Life Sciences. She also regularly collaborates with other agricultural law and tax professionals throughout the country, including those from the Rural Tax Education Committee, the American Agricultural Law Association, and the Land Grant University Tax Education Foundation. Kristine is licensed to practice law in Iowa and Missouri and is a member of the Iowa Bar Association.

Before coming to ISU, Kristine worked for a legal publishing company and as a practicing attorney.

She received her J.D., Order of the Coif, from the University of Texas at Austin and her B.A. in journalism from Iowa State. She grew up on a farm in west central Iowa.

THE TAX CUTS AND JOBS ACT & AGRICULTURAL PRODUCERS Kristine Tidgren Center for Agricultural Law &

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Taxation, Iowa State University Ames, Iowa

TABLE OF CONTENTS I. INTRODUCTION……………………………………………………………………………………………...3 II. KEY CHANGES………………………………………………………………………………………………3 A. Modifying Individual Income Tax Brackets………………………………………...……………………3 B. Increasing the Standard Deduction ............................................................................................................ 3 C. Suspending the Personal Exemption .......................................................................................................... 3 D. Eliminating Many Deductions .................................................................................................................... 3 E. Increasing the Child Tax Credit and Creating a New Dependent Credit ............................................... 4 F. Estate, Gift, and Generation Skipping Tax ............................................................................................... 4 G. Corporate Tax Rate ..................................................................................................................................... 4 H. Deduction for Pass-Through Business Income .......................................................................................... 4 I. Bonus Depreciation ...................................................................................................................................... 7 J. Section 179 .................................................................................................................................................... 8 K. Vehicle Depreciation……………………………………………………………………………………….8 L. Farm Equipment Depreciation ................................................................................................................... 9 M. Cash Accounting…………………………………………………………………………………………...9 N. Net Operating Losses ................................................................................................................................... 9 O. Excess Business Loss Deduction…………………………………………………………………………...9 P. Like-Kind Exchange .................................................................................................................................. 10 Q. Domestic Production Activities Deduction .............................................................................................. 12 R. Business Interest Deduction Limitation…………………………………………………………………12 S. Employer-Provided Meals…………………………………………………………..……………………13 III.

CONCLUSION……………………………………………………………………………………………...13

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I.

INTRODUCTION The Tax Cuts and Jobs Act (TCJA) ushered in the most significant changes to our tax code in more than 30 years.

On December 22, 2017, President Trump signed the TCJA into law. Although most changes went into effect January 1, 2018, meaning that they will impact tax returns filed in 2019, most agricultural clients need to understand how the law is impacting them early in 2018 so they can make good business decisions in the months ahead.

II.

KEY CHANGES Below is an overview of key changes implemented by the new law and how they may impact agricultural producers.

A.

Modifying Individual Income Tax Brackets Most farm businesses are taxed as sole proprietorships, partnerships, or S Corporations. This means that business income is passed through to the owners, who pay taxes based upon individual income tax rates. From 2018 to 2025, the TCJA lowers individual income tax rates across the board. IRC § 1(j). 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%). IRC § 1(j)(2). The TCJA leaves the maximum rates on net capital gains and qualified dividends and the income breakpoints largely unchanged.

B.

Increasing the Standard Deduction Taxpayers only itemize deductions if the amount they can deduct on 1040, Schedule A, is more than their standard deduction. The TCJA will significantly decrease the number of taxpayers who itemize deductions. Beginning in 2018, the TCJA 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. IRC § 63(c)(7)(A). The increased standard deduction is in place through 2025.

C.

Suspending 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, the TCJA suspends the personal exemption from 2018 through 2025. IRC §151(d)(5)(A).

D.

Eliminating Many Deductions The TCJA eliminates or modifies a number of individual itemized deductions for tax years 2018 through 2025.

1.

State and Local Tax Deduction For tax years 2018 through 2025, the TCJA 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). IRC § 164(b)(6)(B). Property taxes incurred in a trade or business, however, continue to be fully deductible on a Schedule C, Schedule E, or Schedule F. IRC §§ 162, 212.

2.

Charitable Contributions The TCJA 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.

The TCJA does not change the ability of those over 70 1/2 to exclude from income qualified charitable distributions from an IRA. IRC 408(d)(8). Nor does it impact the ability of farmers to exclude charitable gifts of grain or other commodities from income. Rev. Rul. 55-138; Rev. Rul. 55-531. These forms of charitable contributions can provide qualified donors with a tax benefit even if they do not itemize.

3. Home Mortgage Interest Deduction Through 2025, the TCJA lowers the home mortgage interest deduction from $1 million ($500,000 married filing separately) to $750,000 ($375,000 married filing separately). IRC 163(h)(3)(F). The TCJA also suspends the deduction for interest paid on a home equity loan, unless that loan is used to buy, build, or substantially improve the taxpayer’s home that secures the loan. IRC 163(h)(3)(B).

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4. Miscellaneous Itemized Deductions Subject to the 2 Percent Floor For tax years 2018 through 2025, the TCJA suspends all miscellaneous itemized deductions subject to the two percent floor, including, for example, unreimbursed employee expenses, hobby expenses, and investment fees. IRC § 67(g).

5. Medical Expenses Deduction The TCJA retains the current itemized deduction for medical expenses exceeding 10 percent of the taxpayer’s adjusted gross income. For tax years 2017 and 2018, however, the TCJA decreases this AGI threshold for everyone (not just those 65 and older) to 7.5 percent. IRC § 213(f)(2).

E.

Increasing the Child Tax Credit and Creating a New Dependent Credit The TCJA raises the child tax credit from $1,000 to $2,000 per qualifying child for tax years 2018 through 2025.

IRC § 24(h)(2). Of this credit, $1,400 per child is refundable. The TCJA also provides a new $500 nonrefundable credit for each dependent who does not qualify for the child tax credit, including those over the age of 16. IRC § 24(h)(4). In addition to receiving a larger child tax credit, more families will qualify for the child tax credit under the TCJA because the phase-out of the credit does not begin until a married filing jointly couple reaches adjusted gross income of $400,000 or a single taxpayer reaches an adjusted gross income of $200,000. Under prior law, the $1,000 credit per child began to phase out when the married filing jointly couple had modified adjusted gross income above $110,000 and the single taxpayer had modified adjusted gross income above $75,000.

F.

Estate, Gift, and Generation Skipping Tax The TCJA did not eliminate the estate or gift tax, but it did double the basic exclusion amount for tax years 2018 through 2025. IRC § 2010(c)(3)(C). Consequently a person can die with an estate worth $11,180,000 (adjusted for inflation) in 2018, and the estate will owe no estate tax. Rev. Proc. 2018-10. Basis adjustment (often a “step up”) continues at death for all estates, whether taxable or non-taxable. IRC § 1014(a)(1).

Although many fewer estates will be subject to estate tax through 2025, the TCJA does not eliminate the need for estate or transition planning. In many cases, however, the focus may turn even more toward planning to avoid the capital gains tax and planning for disability and transitioning the business.

G. Corporate Tax Rate The TCJA permanently lowers the maximum corporate tax rate from 35 percent to 21 percent, beginning in 2018.

IRC § 11(b). C corporations with a fiscal year beginning in 2017 will apply a blended rate incorporating 2017 and 2018 rates, as directed by IRC §15. IRS Notice 2018-38. Because the law transforms the corporate tax structure to a flat rate for all income, small C corporations with income below $50,000 will see an increase in their corporate income tax rate from 15 percent to 21 percent. Such entities may consider electing S corporation status. S corporations subject to the built-in gains tax will see a new rate of 21 percent instead of 35 percent.

H. Deduction for Pass-Through Business Income From 2018 through 2025, the TCJA allows most individuals receiving income from a sole proprietorship or a pass through business—including an S corporation or a partnership—to take a new “Section 199A” deduction. IRC § 199A. This provision was intended to ensure that pass-through businesses also receive a tax rate reduction under the TCJA. Because these businesses are taxed at the owner level, however, this tax break is provided through a deduction instead of a general rate reduction. The 199A deduction is arguably the most complex portion of the new tax law. It is also a provision for which much IRS guidance is needed. On August 8, 2018, IRS and Treasury issued initial guidance through proposed regulations, REG-107892-18. This section provides a general overview of the new 199A deduction and initial IRS guidance.

1.

Qualified Business Income

IRC § 199A generally allows a 20 percent deduction for “qualified business income” (QBI), defined as the “net amount of qualified items of income, gain, deduction, and loss with respect to any “qualified trade or business” of the taxpayer. Such term shall not include any qualified REIT dividends or qualified publicly traded partnership income.

IRC § 199A(c). Qualified businesses income must be “effectively connected with the conduct of a trade or business within the United States.” IRC § 199A(c)(3)(A). The law specifically excepts from the definition of “qualified 4

business income” (QBI) capital gain, dividends, interest income not allocable to a trade or business, non-business annuity income, and any losses or deductions allocable to those items. IRC § 199A(c)(3)(B). Qualified business income also does not include reasonable compensation received by an S corporation shareholder, or guaranteed payments received by a partner in a partnership. IRC § 199A(c)(4).

Section 199A requires that qualified business income eligible for the 199A deduction must come from a “qualified trade or business.” The proposed regulations state that for purposes of 199A, IRC § 162(a) provides the most appropriate definition of “trade or business.” IRS notes that the definition is “derived from a large body of existing case law and administrative guidance interpreting the meaning of trade or business in the context of a broad range of industries.” Yet there is no bright-line definition of what types of rental activities constitute trades or businesses for purposes of IRC § 162. The courts make trade or business determinations on a case-by-case basis after a highly factual inquiry. The best “definition” for an IRC § 162 “trade or business” is the most recent guideline from the U.S. Supreme Court: To be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). A sporadic activity, a hobby, or an amusement diversion does not qualify. Id. For more information on this issue, see https://www.calt.iastate.edu/blogpost/despiteguidance-lots-questions-remain-regarding-rental-income.

Solely for purposes of IRC § 199A, the regulations do provide that the rental of property to a related trade or business is automatically treated as a trade or business if the rental and the other trade or business are commonly controlled (regardless of whether the rental activity and the trade or business are otherwise eligible to be aggregated under § 1.199A-4(b)(1)). But for all other rentals, a fact-based determination must be made as to whether the rental is a "trade or business" before the 199A deduction may be claimed.

2.

Calculating the Deduction A taxpayer’s Section 199A deduction generally may not exceed 20 percent of his or her taxable income, reduced by net capital gain. IRC § 199A(a)(1). The § 199A deduction reduces taxable income, not adjusted gross income.

IRC § 63(b). As such, limitations based upon AGI (such as payment limitations for farm programs) are not impacted by the new IRC §199A deduction. Taxpayers are not required to itemize to claim the Section 199A deduction.

3.

Wages/Capital Limitation The 199A deduction for qualified business income is generally subject to a wages/capital limitation; however, the phased-in limitation only applies to individuals with taxable income greater than $315,000 (MFJ) or $157,500 for singles. IRC § 199A(b)(2). Once these income levels are reached, the limitation is phased in for the next $100,000 of income (MFJ) or $50,000 for singles. IRC § 199A(b)(3).

The wages/capital limitation, which begins with the wages limitation from the repealed DPAD, also incorporates an alternative capital component. IRC § 199A(b)(2). The limitation is the greater of the following:  

50 percent of the W-2 wages paid with respect to the qualified trade or business, or The sum of 25 of percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

4.

Income from Sales to Agricultural Cooperatives Originally, IRC § 199A provided a separate 20 percent deduction for “qualified cooperative dividends.” This provision, which was hastily written and not well vetted, would have allowed many farmers selling commodities to cooperatives a 20 percent deduction for their gross sales to the cooperative. This was because the definition of “qualified cooperative dividend” encompassed per-unit retains paid in money (PURPIM), as well as traditional patronage dividends. IRC § 199A(e)(4). The payments made by agricultural cooperatives to their patrons for their gross sales are often characterized as PURPIM. Thus, this provision would have, in many cases, meant tax free income to the cooperative patron (expenses are often 80 percent of gross sales). A fix to this provision was included in the Consolidated Appropriations Act, 2018, H.R. 1625, signed by the President on March 23, 2018.

Instead of the 20-percent deduction calculated based upon gross sales, the cooperative patron is now subject to a new bifurcated calculation and a hybrid 199A deduction. Essentially, the fix gives the cooperative patron a deduction that blends the new 199A deduction with the old 199 DPAD deduction (all within the new 199A). Depending upon their individual situations, cooperative patrons may be advantaged, disadvantaged, or essentially treated the same by selling to a cooperative rather than selling to a non-cooperative. While the significant advantage is gone, the complexity certainly is not.

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First, patrons calculate the 20 percent 199A(a) QBI deduction that would apply if they had sold the commodity to a non-cooperative. The patron must then, pursuant to 199A(b)(7), subtract from that tentative 199A(a) deduction amount the lesser of the following to reach the final QBI deduction:  

9 percent of net income attributable to cooperative sale(s) OR 50 percent of W-2 wages they paid to earn that income from the cooperative

Note that if the patron does not pay W-2 wages to any employees, no reduction is required. Under the revised IRC §199A(g), cooperative patrons get to take an additional “DPAD-like” deduction (if any) passed through to them by the agricultural cooperative. The determination of the amount of this new “DPAD-like” deduction, will depend upon the amount of the cooperative's qualified production activities income (QPAI) attributable to that patron's commodity. The cooperative generally receives a 199(g) deduction equal to nine percent of its QPAI. The final amount passed through to the patron is at the discretion of the cooperative. It is governed by language copied directly from the old DPAD provision. In any event, the overall amount a cooperative can choose to pass through to its members cannot exceed 50 percent of the value of the wages the cooperative pays to its employees. The patron’s 199A(g) deduction cannot exceed taxable income (subtracting the 20 percent QBI deduction detailed above, but not subtracting capital gain). a.

Example One Pat Patron, a single taxpayer, is a member patron of Big Coop. In 2018, he sells all of his grain through Big Coop.

Pat receives $250,000 from Big Coop in 2018 for his grain sales. He receives $230,000 of this as a per unit retain paid in money (PURPIM) and $20,000 as an end-of-year patronage dividend. Pat also has $200,000 in expenses, which does not include any W-2 wages in 2018. Pat has no capital gain income in 2018, but he receives wages from an outside job, leaving him with taxable income of $75,000 (after the $12,000 standard deduction is subtracted).

Pat’s 2018 qualified business income (QBI) is $50,000, which equals his net income from his grain marketing activities. Under 199A(a), Pat calculates a tentative QBI deduction of $10,000, which is .20 of his QBI. Because Pat’s taxable income is below $157,500, his QBI deduction is not limited by the wages / capital limitation.

Because all of Pat’s tentative QBI deduction is attributable to qualified payments he received from Big Coop, Pat must determine what portion of that deduction must be reduced under 199A(b)(7). He must reduce his QBI deduction by the lesser of:  9 percent of QBI allocable to qualified payments from cooperative ($50,000 * .09 = OR $4,500) OR  50 percent of W-2 wages attributable to Pat’s coop payments ($0) Because Pat paid no wages for his grain business, he is not required to reduce his QBI deduction at all. He is therefore entitled to the full 20 percent 199A(b) deduction. Assume that in 2018, Big Coop also allocates a $2,500 199A(g)(2)(A) deduction to Pat for his portion of the Coop’s QPAI. This deduction is limited only by Pat’s taxable income (after subtracting his QBI deduction). Pat’s final 199A deduction for 2018 is $10,000 (QBI) + $2,500 (199(g)) = $12,500 (25 percent of QBI). Pat’s final taxable income in 2018 is therefore $75,000 - $12,500 = $62,500. b.

Example Two We will now change only one fact from Example One. Here, we assume that $25,000 of Pat’s $200,000 in expenses were W-2 wages that he paid to an employee. Here, Pat’s tentative 199A(a) QBI deduction will remain $10,000 (20 percent of QBI). However, he must now reduce his QBI deduction by the lesser of the following:  9 percent of QBI allocable to qualified payments from cooperative ($50,000 * .09 = OR $4,500) OR  50 percent of W-2 wages attributable to Pat’s coop payments ($25,000 * .5 = $12,500) Here, Pat must subtract $4,500 from his $10,000 tentative deduction for a final QBI deduction of $5,500. Pat thus gets only an 11 percent QBI deduction in this example. However, Pat also get to take his $2,500 199A(g) deduction from Big Coop, for a final 199A deduction of $8,000 (16 percent of QBI). Pat’s final taxable income in this example is $67,000. c.

Deduction for Agricultural Cooperatives The fix also significantly changes the deduction allowed to agricultural cooperatives themselves. Under the original 199A, the cooperative would have received its own 20-percent deduction, calculated based upon gross income minus qualified cooperative dividends paid. This deduction was also limited by a wages/capital restriction.

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Under the fix, this approach is replaced by the "DPAD-like" regime discussed above. The cooperative can take a new 199A(g) deduction in an amount equal to 9 percent of “QPAI” (which includes PURPIM), limited by taxable income and 50 percent of W-2 wages paid. If the cooperative passes the 199A(g) deduction through to its patrons, it must reduce, in a corresponding amount, the deductions it could normally take for its payments to the patrons. d.

Corporate Patrons The 199A deduction, including the new 199A(g) does not apply to patrons that are C Corporations. Specifically, the 199A(g)(A) deduction, although modeled after the old DPAD, is now restricted to "eligible taxpayers," which are taxpayers "other than a corporation." 199A(g)(2)(D). Likewise, 199A(g)(2)(C) limits the cooperatives' own deduction only by qualified payments attributed to “eligible taxpayers.” This is because the new 199A(g) can only be passed through to non-corporate taxpayers (including shareholders of S Corporations). e.

Transition Rule The new law also includes a transition rule for patrons who receive a cooperative payment in 2018 that is attributable to QPAI for which the old DPAD 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.

5.

Service Trade or Businesses Specified service trade or businesses are generally excluded from taking the Section 199A deduction because they are excluded from the definition of a “qualified trade or business.” IRC § 199A(d)(1)(A). Like the W-2 wages/capital limitation, however, this restriction is phased in, based upon taxable income. The services business limitation begins to apply to taxpayers with taxable income greater than $315,000 (MFJ) or $157,500 for singles. Once these income levels are reached, the limitation phases in over the next $100,000 of income for MFJ or $50,000 for singles. IRC § 199A(d)(3)(A). A specified service trade or business is defined as follows: services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of the owner or 1 or more of its employees….

IRC § 199A(d)(2)(A)(citing IRC § 1202(e)(3)(A)). Additionally, the law states that investment management, trading or dealing in securities would be a specified service trade or business. The proposed regulations significantly limit the reach of the SSTB definition. Proposed §1.199A-5. Farm property managers, real estate agents, and insurance brokers are not in a SSTB. Veterinarians, however, are providing services in the field of health and are in an SSTB. I.

Bonus Depreciation The TCJA allows 100 percent bonus depreciation through 2022 for qualifying property acquired and placed into service after September 27, 2017. IRC § 168(k)(6)(A). The percentage then phases down over the next four years, in increments of 20. IRC § 168(k)(A). This phase-out is as follows:    

2023: 80 percent bonus, 2024: 60 percent bonus, 2025: 40 percent bonus, and 2026: 20 percent bonus.

After 2026, bonus depreciation ends. Property acquired before September 28, 2017, but placed in service on or after that date, is subject to pre-Act phase-down limits (i.e. 40 percent in 2018). Notably, the TCJA extended bonus depreciation to used property, as well as new property, by removing the requirement that the first use of the property originate with the taxpayer. IRC § 168(k)(2)(A)(ii). For qualifying property, additional first-year depreciation is automatic. Taxpayers must affirmatively elect out of the deduction for any class of property to which they do not want bonus depreciation to apply. IRC § 168(k)(7). During the first tax year ending after September 27, 2017, taxpayers could choose to elect 50 percent bonus, instead of 100 percent bonus. IRC § 168(k)(10)(A). Once these elections are made, they cannot be changed without IRS consent.

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J.

Section 179 Beginning in 2018, the TCJA permanently 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 $2,030,000 in 2017). IRC § 179(b)(1), (2).

This amount will be indexed for inflation beginning in 2019. IRC § 179(b)(6). Unlike bonus depreciation, the Section 179 expense deduction must be affirmatively elected each year. Taxpayers may make an election or revoke an election on an amended return. This is a useful provision for many agricultural producers who cannot always predict their income and the usefulness of the election long-term.

K.

Vehicle Depreciation

1.

2018 Limits for "Passenger Automobiles" For passenger automobiles placed into service after December 31, 2017, section 13202 of the TCJA significantly increases the dollar limitations on depreciation and expensing for passenger automobiles. For 2018, the amount of the depreciation and expensing deduction for a passenger car or light duty truck or van shall not exceed—  $10,000 for the 1st taxable year in the recovery period,  $16,000 for the 2nd taxable year in the recovery period,  $9,600 for the 3rd taxable year in the recovery period, and  $5,760 for each succeeding taxable year in the recovery period.

These numbers shall be adjusted for inflation after 2018. As such, for 2018, the limits for light-duty trucks, vans, and passenger cars are the same. The TCJA retained the $8,000 limit for additional first-year depreciation for passenger automobiles. So in 2018, the maximum amount a taxpayer can deduct for a passenger automobile in the first year is $18,000.

2.

The Unusual Interplay of 100 Percent Bonus and IRC § 280F Taxpayers who purchase a passenger automobile subject to the IRC § 280F limitations must consider the impact of taking bonus depreciation on future depreciation deductions. The last time we had 100 percent bonus, Rev Proc.

2011-26 stated that If the unadjusted depreciable basis of a passenger automobile exceeded the first-year limitation amount under § 280F(a)(1)(A)(i), the excess amount was the unrecovered basis of the passenger automobile for purposes of § 280F(a)(1)(B)(i) and, therefore, not deductible until the first taxable year succeeding the end of the recovery period. And then it was subject to the limitation under § 280F(a)(1)(B)(ii). In other words, under this interpretation, if a taxpayer buys a $45,000 car in 2018, he or she can immediately depreciate $18,000, but the remaining $27,000 would not be depreciable until year 2024.

Rev. Proc. 2011-26 provided a safe harbor work around for this problem in 2011. For years after the first-year deduction, the guidance generally allowed taxpayers to determine the unrecovered basis of the passenger automobile for its placed-in-service year as though the taxpayer claimed 50-percent, instead of the 100-percent, bonus depreciation. This was a complex “solution” and until IRS guidance issues further guidance, we won’t be sure how it will handle the current issue.

3.

Larger Vehicles SUVs with a gross vehicle weight rating above 6,000 lbs. are not subject to depreciation limits. They are, however, limited to a $25,000 IRC §179 deduction. IRC § 179(b)(5)(A). No depreciation or §179 limits apply to SUVs with a GVW more than 14,000 lbs. Trucks and vans with a GVW rating above 6,000 lbs. but not more than 14,000 lbs. generally have the same limits: no depreciation limitation, but a $25,000 IRC §179 deduction. These vehicles, however, are not subject to the §179 $25,000 limit if any of the following exceptions apply:  The vehicle is designed to have a seating capacity of more than nine persons behind the driver's seat;  The vehicle is equipped with a cargo area at least 6 feet in interior length that is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment; or  The vehicle has an integral enclosure, fully enclosing the driver compartment and load-carrying device, does not have seating behind the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.

Although SUVs purchased after September 27, 2017, remain subject to the $25,000 IRC § 179 limit, they are eligible for 100% bonus depreciation if they are above 6,000 lbs. This is true for both new and used vehicles. For a 8

taxpayer’s first taxable year ending after Sept. 27, 2017, taxpayers may elect to apply a 50 percent allowance instead of the 100 percent allowance. To make the election, they must attach a statement to a timely filed return (including extensions) indicating they are electing to claim a 50% special depreciation allowance for all qualified property.

Once made, the election cannot be revoked without IRS consent. As noted above, taxpayers may also elect out of bonus entirely for any class of property by filing an election on a timely filed return. Once filed, such an election cannot be revoked without IRS consent.

L.

Farm Equipment Depreciation Beginning in 2018, new farm machinery or equipment is depreciated over a period of five years, instead of seven.

IRC § 168(e)(3)(B)(vii). This change does not apply to grain bins, cotton ginning assets, fences, or other land improvements. The TCJA provides that farmers will use the 200 percent declining balance method of MACRS depreciation for many farming assets placed into service in 2018 or later. IRC § 168(b)(2). Before this change, most farming property was depreciated using the 150 percent declining balance method. This change does not generally apply to (1) buildings and trees or vines bearing fruits or nuts, (2) property for which the taxpayer elects either the straight-line method or 150% declining balance method, (3) 15 or 20-year MACRS property that must be depreciated under the 150% declining balance method, or (4) property to which the alternative depreciation system applies.

Farmers can elect to use 150 percent declining balance method.

M. Cash Accounting IRC § 448(b)(1) excepts a “farming business” from its general requirement that C corporations and partnerships with a C corporation partner use the accrual method of accounting. For this purpose, “farming business” means the trade or business of farming within the meaning of Code Sec. 263A(e)(4). IRC § 448(d)(1)(A). IRC § 447(a), however, generally requires that taxable income arising from the trade or business of farming for a C corporation or a partnership with a C corporation partner is to be computed using the accrual method.

For purposes of this sub-section, the “trade or business of farming” does not include operating a nursery or sod farm or raising or harvesting of trees (other than fruit and nut trees). Prior to the TCJA, §447 also removed from its accrual accounting requirement (1) farming corporations with $1 million or less in gross receipts in any tax year beginning after 1975 and (2) “family corporations” with gross receipts of $25 million or less.

The TCJA has significantly expanded the availability of the cash method of accounting to farming C corporations and partnerships with a C corporation partner. Beginning in 2018, the IRC § 447 accrual accounting requirement does not apply to any farming corporation that meets the gross receipts test of IRC § 448(c), which is $25 million or less in 2018. The gross receipts test is applied using three-year averaging rules. For purposes of the IRC § 447(a) accrual accounting requirement, a C corporation that meets the gross receipts test for any taxable year is not treated as a corporation at all for that taxable year. IRC § 447(c)(2). This means that partnerships with such C corporations as partners are also not required to use the accrual method of accounting. Farming S Corporations continue to be wholly excluded from an accrual accounting requirement, regardless of gross receipts. IRC § 447(c)(2).

N.

Net Operating Losses The TCJA reduces the five-year carryback of net operating losses for a farming business to two years. IRC § 172(b)(1)(B). It also limits the net operating loss deduction to 80 percent of taxable income for losses incurred after December 31, 2017. IRC § 172(a)(2). The new law, however, allows indefinite carryovers, instead of the 20-year carryover allowed under prior law. IRC § 172(b)(1)(A)(ii). Net operating losses incurred prior to 2018 are still allowed to be deducted against 100 percent of taxable income.

O.

Excess Business Loss Disallowance The TCJA also implements an excess business loss rule that replaces (and expands upon) the excess farm loss rule. The excess farm loss rule applied to non-corporate farmers who received an applicable subsidy. Under this rule, these non-corporate farmers’ losses were limited to a threshold amount of $300,000 ($150,000 for married filing separately). Excess farm losses could be carried over to future years. The TCJA suspends the excess farm loss rule for years 2018 through 2025, and replaces it with an excess business loss rule (which also expires in 2026). The new excess business loss rule applies to all non-corporate taxpayers, not just those involved in farming and not just those farmers receiving an applicable subsidy. IRC § 461(l). Under IRC § 461(l)(3)(A), an “excess business loss” is one that exceeds $500,000 (married filing jointly) or $250,000 (single). These limit amounts will be indexed for inflation after 2018. Any loss disallowed by this rule will be treated as a net operating loss, but apparently only subject to a carryforward.

9

P.

Like-Kind Exchange The TCJA retained IRC §1031 like-kind exchange gain recognition deferral for real property, but eliminated it for personal property, such as farm equipment or livestock. IRC § 1031(a)(1).

1.

Prior Law Under 2017 law, IRC § 1031 non-recognition treatment was mandatory for a qualifying exchange of personal property. Those who did not want to apply §1031 like-kind exchange rules to a trade typically had to structure the transaction as a clear sale and purchase to avoid being automatically deemed a like-kind exchange by IRS and the courts. Taxpayers could generally accomplish this by selling the old asset to a different party than the one from whom the new asset was purchased.

With a §1031 exchange, gains or losses on the exchange of like-kind personal property used in a trade or business were generally deferred. This meant that if a farmer traded a fully depreciated piece of equipment for a newer model, the like-kind exchange rules applied, and recognition of IRC § 1245 recapture was deferred. If a farmer traded several raised breeding heifers for some like-kind cows, § 1231 gain would be deferred on that transaction as well. In a like-kind exchange, the basis of the relinquished property was carried over to the basis of the replacement property, and gain recognition was rolled ahead until such time as the replacement property was sold. Specifically, the basis of the replacement property was equal to: Basis of the relinquished property - Boot received + Boot paid + Gain recognized - Loss recognized a.

Example Gain (but not loss) was recognized only to the extent that the boot received exceeded the gain realized. A loss was recognized only if property given was not like-kind and the adjusted basis exceeded its FMV. A basic example illustrates this formula: In 2017, John traded a tractor with a FMV of $75,000 and an adjusted basis of $0 for a tractor with a fair market value of $125,000, plus $50,000 in cash.

Under old law, applying automatic like-kind exchange treatment, IRC § 1245 recapture was deferred, and the basis in John’s replacement tractor was $50,000 ($0 basis in relinquished tractor, plus boot paid). John reported the transaction on Form 8824, and could generally use IRC § 179 to immediately expense $50,000, the amount of boot paid in the transaction.

2.

Current Law

The Tax Cuts and Jobs Act, H.R.1, amended IRC § 1031 by striking the word “property” and replacing it with “real property.” This means that like-kind exchange treatment is still available for real property, but it is gone permanently for personal property, beginning in 2018.

A transition rule provides that a qualifying personal property exchange where either the property was disposed of or received by the taxpayer on or before December 31, 2017, is still subject to like-kind exchange treatment. With no § 1031 treatment available to personal property in 2018, equipment or livestock “trades” will be treated as taxable events, with the taxpayer computing gain or loss based upon the difference between the amount realized on the sale of the relinquished asset and the party's adjusted basis in the asset. “Amount realized” includes any money, as well as the fair market value of property (other than money) received in the transaction. IRC §1001(b). There will be no tax deferral for §1231 gains or §1245 recapture. There will also be no deferral for a loss. a.

Largely Offset by Increased Expensing and Depreciation Options Increased expensing and bonus depreciation options must be considered in assessing the overall impact of the loss of the 1031 exchange for personal property. The Act generally allows just over five years of 100 percent bonus depreciation for qualifying property acquired and placed into service after September 27, 2017 (taxpayers can elect to use 50 percent bonus for 2017 purchases). Beginning in 2023, the Act would then allow one year of 80 percent bonus, one year (2024) of 60 percent bonus, one year (2025) of 40 percent bonus, and one year (2026) of 20 percent bonus. After that time, bonus depreciation will end.

Important for this purpose, the Act provides that the enhanced first-year additional depreciation property 10

provisions apply to used property, as well as new property (beginning with property acquired and placed into service after September 27, 2017).

Beginning in 2018, the Act also expanded 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 $2,030,000 in 2017). These amounts will be indexed for inflation beginning in 2019. These provisions are not set to expire. b.

Example of “Trade” under New Law The following example illustrates 2018 tax treatment of an equipment “trade” in light of the new law: In 2018, John “trades” a tractor with a FMV of $75,000 and an adjusted basis of $0, plus $50,000 cash for a tractor with a fair market value of $125,000.

In 2018, this transaction will be treated as a sale and a purchase. John must now recognize $75,000 in § 1245 recapture (the difference between the FMV of the traded tractor ($75,000) and its adjusted basis ($0)). This transaction will be reported on Part III of Form 4797 and taxed as ordinary income (no self-employment tax). John uses the proceeds of the sale, plus an extra $50,000 in cash, to purchase the new tractor. Thus, John’s basis in his new tractor will be $125,000, the full purchase price of the new tractor. John can likely use IRC § 179 to expense this amount in 2018. If Section 179 is not available, he can use 100 percent bonus to capitalize and depreciate the full amount in 2018.

3.

Other Considerations In 2017 and 2018, John from our above examples will have the same total income on his Form 1040.

However, the difference between a § 1031 exchange and a sale and purchase is not one without distinction. a.

Self-Employment Tax Considerations Choosing to apply higher amounts of IRC §179 or bonus depreciation to offset the recognized § 1245 gain will result in lower net Schedule F income, thereby reducing SE income. While this means less SE tax, it also means less retirement income down the road. This is an important planning consideration. In the 2017 example above, assume John otherwise had $125,000 in net Schedule F income. With like-kind exchange treatment, John deferred $75,000 in § 1245 gain, and expensed $50,000 (the cash boot paid). This meant that John’s Schedule F income was reduced to $75,000. This income is subject to SE tax. In 2018, also assume John otherwise has $125,000 in net Schedule F income. Now he must recognize the $75,000 in recapture income, which is not reported on Schedule F, but on Form 4797, Part III. But John can now expense (or depreciate using bonus depreciation) the full amount of his $125,000 purchase on Schedule F. This will result in $0 in Schedule F income and no SE tax liability. b.

New 199A Deduction Considerations The new IRC § 199A creates a new deduction for “qualified business income.” This deduction can generally be taken in an amount up to 20 percent of “qualified business income.” IRC § 1245 recapture reported as gain on Form 4797 should qualify as a component of qualified business income. QBI is defined as the “net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer. Such term shall not include any qualified REIT dividends, or qualified publicly traded partnership income.” IRC § 199A(c)(1). The law also excludes wages, reasonable compensation, guaranteed payments, interest income, dividend income, and capital gain from the definition of QBI. IRC § 199A(c)(3)(B). Proposed regulations also clarify that IRC § 1231 gain or loss is excluded from the definition of QBI to the extent that it is treated as a capital gain or loss. In other words, such capital gain or loss is excluded from the definition of QBI whether or not it arises from the sale or exchange of a capital asset. Specifically, QBI does not include any item taken into account in determining net longterm capital gain or net long-term capital loss.

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c.

Loss Considerations The sale/purchase treatment (as opposed to the like-kind exchange treatment), may be useful in some cases to create ordinary income to offset a net operating loss carryforward. Careful planning is necessary to properly handle expensing and depreciation elections in light of other income. d.

Reporting of the Sales Price In the past, the adjusted basis of the relinquished property was reported on Form 8824 and carried forward to the replacement property. That number was readily available from depreciation schedules. Now, the gross sales price of the property must be reported on Form 4797, in addition to the adjusted basis.

Under IRC § 1001(b), the sales price should equate to the fair market value of the relinquished property. In other words, an accurate trade-in value will be important. IRS may issue regulations governing the reporting of exchanges in light of the new law. e.

Permanent v. Temporary The elimination of like-kind exchange treatment for personal property is permanent, as is the enhanced IRC § 179 deduction. 100 percent bonus depreciation, however, is available only through 2022 before it begins to taper down. It will be eliminated fully in 2027. In any event, permanent or temporary only means until the next Congress changes its mind. f.

Exchanges Occurring Between September 28, 2017, and December 31, 2017 As noted above, 100 percent additional first year depreciation is available to qualifying property acquired and placed into service after September 27, 2017. This includes used property. Consequently, there is a three-month window (for individual calendar year taxpayers) where 100 percent bonus depreciation and IRC §1031 treatment for like-kind personal property coexist. The new law allows 100 percent bonus to apply only to the boot paid in such like-kind exchanges. This is because IRC § 168(k)(2)(E)(ii) states that property qualifying for bonus depreciation must meet the requirements of IRC § 179(d)(3), which states that “the cost of property does not include so much of the basis of such property as is determined by reference to the basis of other property held at any time by the person acquiring such property.” This is true whether the taxpayer elects to take 100 percent bonus or 50 percent bonus, as is available during the first tax year ending after September 27, 2017, under IRC § 168(k)(10).

Note: For assets purchased before September 28, 2017, 50 percent bonus would apply to both the boot and the adjusted basis of the relinquished property, although section 179 could only be used to expense the amount of the boot paid. g.

Impact of State Taxation How states choose to respond to the new federal tax laws will have large implications for taxpayers.

Q. Domestic Production Activities Deduction The TCJA eliminates the DPAD deduction, which was frequently used by agricultural producers and cooperatives. (repealed IRC § 199).

R.

Business Interest Deduction Limitation Although the TCJA has restricted business interest deductions generally to 30 percent of adjusted gross income (beginning in 2018), those restrictions do not apply to taxpayers that meet the $25 million gross receipts test of IRC § 448(c). IRC § 163(j)(3). The TCJA also allows a “farming business” (as defined in IRC § 263A(e)(4)), as well as a specified agricultural or horticultural cooperative to elect not to be subject to the business interest limitation. An electing farm business isn’t a “trade or business” for purposes of the business interest limitation. IRC §163(j)(7)(A)(iii). An electing businesses, however, is required to use the alternative depreciation system (ADS) to depreciate any farming assets with a recovery period of 10 years or more. IRC § 168(g)(1)(G). This also means the farmer cannot use bonus depreciation on those assets. Once this election is made, it is irrevocable. IRC § 163(j)(7)(C).

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S.

Employer-Provided Meals The TCJA reduces the deduction for meals provided for the convenience of the employer to 50 percent through 2025. After that time, the deduction is eliminated fully.

III. CONCLUSION The TCJA is the biggest change to the tax code since 1986. Although we have some proposed guidance, it may take some time before certain provisions, such as the IRC §199A deduction, are understood in practice. Some farming businesses may need to make changes to their business structure in response to the new law. One significant issue for many taxpayers is how their states will respond to the new federal law. In states with an income tax, legislators are working to determine to what extent their states’ tax codes should conform to federal law.

13

Steven K. Huff 1

Steve is a native of Sioux City, Iowa. He graduated from the University of Northern Iowa in 1993 with a major in political science and minor in English. Three days after graduating from UNI, Steve started law school at the University of Iowa. Steve completed his law degree in two years and three months and graduated from Iowa With Distinction. While in law school, Steve worked as a research assistant for Professor Sumi Cho, as a law clerk for Califf & Harper, P.C., in Rock Island, Illinois, and authored a research project for the Moot Court Board.

After graduation, Steve went to work as a law clerk for the State of Iowa’s district court judges (Districts 5A-5C) from July 1996 to May 1998. During his clerkship, Steve assisted Judge Arthur Gamble in presiding over the trial of Linda Rae Channon versus United Parcel Services, which ultimately resulted in the largest verdict in Iowa’s history ($88M verdict after a five week trial).

Steve also assisted the district judges with various criminal, civil and family law matters in a thirteen county area throughout south central Iowa.

Steve began his career in the private sector with the firm of Finley, Alt, Smith, Scharnberg, Craig, Hilmes, and Gaffney, P.C. in Des Moines, Iowa. Steve and his wife Tracy moved to Yankton in 1999 when Steve became associated with the firm. In 2004, Steve became a partner. Steve’s practice areas include commercial litigation, creditor rights and collection work, creditor side bankruptcy work, and general civil litigation.

Steve served as the Yankton County Bar Association president from 2000-2006. Steve now serves as President of East River Legal Services and Yankton County Emergency Services. Steve is also a board member on Habitat for Humanity for Yankton County.

Steve and Tracy have two children. When not working or spending time with family, Steve enjoys cooking (BBQ, Italian, and Chinese, among other types), fitness, and NFL/fantasy football.

How to Manage the Trenches During the Farm Crisis 2

Steven Huff Marlow, Woodward & Huff Yankton, SD

HOW TO MANAGE THE TRENCHES DURING THE IMPENDING FARM CRISIS I.

SKH BIO - www.mwhlawyers.com

•

Worked in the tri state area (SD, IA and NE), primarily for banks and secured creditors, since 1999

•

duties typically range from financial ENT to, on occasion, financial corronor

•

philosophy for clients is that it is usually better for the off track client to get back on track or for a deal to be made than to push the remedial limit

•

typically better to be working with good lawyers or client reps than pro se or inexperienced advisors

•

currently on board of directors for ERLS and part of SD Bar executive team supporting President Reed Rasmussen

II.

AG MARKET TRENDS

•

Agree with Laura on downward economic trends - uncertain markets with threat of greater ag tariffs making a tough situation worse - subsidies inadequate to stave off erosion if process continues to escalate, particularly with China and Canada Real estate prices holding for good ground; in SE SD real estate prices eroding for marginal or less than ideal ground Interest rates will continue to rise and that can make deal making more difficult (Till) Implement prices rising Ag lenders are getting more risk adverse, letting go marginal or less performing cash flow operations, requiring more for renewals; aggressive secondary market filling gap akin to title or secondary loan market LARGEST NUMBER OF CHAPTER 12 FILINGS IN SOUTH DAKOTA SINCE 1998 ACCORDING TO THE SDBK CLERK OF COURT NEWSLETTER

• • • •

•

III

MEDIATION

•

Mandatory versus voluntary - debtor can initiate but typically does not; 99% mandatory process initiated by the creditor creditor can take action without mediation if there is waste but what the holy hell is that?

•

54-13-10. Mandatory mediation--Requirements--Voluntary mediation. A creditor desiring to commence an action or a proceeding in this state to enforce a debt totaling fifty thousand dollars or greater against agricultural land or agricultural property of the borrower or to foreclose a contract to sell agricultural land or agricultural property or to enforce a secured interest in agricultural land or agricultural property or pursue any other action, proceeding or remedy relating to agricultural land or agricultural property of the borrower shall file a request for mandatory mediation with the director of the agricultural mediation program. No creditor may commence any such action or proceeding until the creditor receives a mediation release as described in this chapter, or the debtor waives mediation or until a court determines after notice and hearing, that the time delay required for mediation would cause the creditor to suffer irreparable harm because there are reasonable grounds to believe that the borrower may waste, dissipate, or divert agricultural property or that the agricultural property is in imminent danger of deterioration. Dismissal of a bankruptcy proceeding, abandonment by a bankruptcy trustee, release or relief from a bankruptcy stay, or release or termination of a receivership proceeding shall have the effect of a mediation release. Any debt that is less than fifty thousand dollars may be mediated through a voluntary mediation if a request is made and accepted by both borrower and creditor.

•

not many cases on irreparable harm or waste - states that have similar language do not have holdings that address this concern - failing to pay rent and still try to plant = waste?

Should be but no specific authority in SD or neighboring states - hang hat on deterioration

•

also note that dismissal of a BK, abandonment by a trustee, release of a receivership also acts as a mediation release

•

always check your definitions - particularly what is a ‘borrower’ for purposes of mediation 54-13-1(4) "Borrower," an individual, corporation, trust, cooperative, joint venture, or any other entity entitled to contract who is engaged in farming or ranching and who derives more than sixty percent of total gross income from farming or ranching and who has been extended agricultural credit;

•

borrowers waive by not responding timely to SD DOA deadlines or can do so after default before or during process in writing - rare but done where mediation did not work before and/or bad blood where assets are known to be missing or multiple informal

MOUs have failed - agree more often than not mediation is a worthy process •

sometimes a failed mediation can turn into a successful MOU or non court resolution (DIL, VFA refi or part/full liquidation)

IV. VFAs - VOLUNTARY FORECLOSURE AGREEMENTS •

Best for both creditor and debtor where debtor is upside down (more liabilities than assets) and the real estate collateral has lots of junior liens, judgments and mortgages

•

debtor gets to walk away from all indebtedness in exchange for giving creditor immediate possession of real estate and

21-48A-1. Voluntary foreclosure procedure--Notice. Upon the mutual written agreement of the mortgagor and mortgagee, a real estate mortgage may be foreclosed pursuant to this chapter by doing all of the following: (1)

The mortgagor shall convey to the mortgagee, subject to acceptance, all interest in

the real property subject to the mortgage; (2) The mortgagee shall accept the mortgagor's conveyance and waive any rights to a deficiency against the mortgagor arising from the mortgage; (3) The mortgagee shall have immediate possession of the real property; (4) The mortgagor and mortgagee shall file a jointly executed document with the register of deeds stating that the mortgagor and mortgagee have elected to follow the alternative voluntary foreclosure procedures pursuant to this chapter; (5) The mortgagee shall send by certified mail a notice of the election to all junior lienholders as of the date of the conveyance under subdivision (1) of this section, determined from the records of the applicable clerk of courts and register of deeds, stating that the junior lienholders have sixty days from the date of mailing to exercise any rights of redemption. Such notice shall also include the sum necessary to redeem the premises. Such sum may include the principal debt, interest thereon at the applicable rate, and all other payments made by the mortgagee and reasonably incurred to protect the first mortgagee's mortgage, and to preserve and protect the property, including reasonable attorney's fees; (6) On the date of the written agreement provided in this section, the mortgagee shall furnish the mortgagor a completed form in duplicate, captioned "Disclosure and Notice of Cancellation". The form shall be attached to said written agreement, shall be in conspicuous type and shall be in the following general form: "DISCLOSURE AND NOTICE OF CANCELLATION _________________________ (enter date of transaction) South Dakota foreclosure law requires that you have the right to redeem your property from foreclosure. If you agree to this voluntary foreclosure you will be giving up your right to redeem your real estate.

Under foreclosure law, if your mortgage lender does not receive enough money to cover what you owe when the property is sold, you could be required to pay the deficiency. If your mortgage lender receives more money than you owe, the difference must be paid to you. If you agree to this voluntary foreclosure you will not have to pay any deficiency but you also will not be paid any excess, if any.

NOTE: There may be other advantages and disadvantages, including an effect on your income tax liability. If you have any question or doubts, you are encouraged to obtain competent advice.

You may cancel this transaction, without penalty or obligation, within five business days from the above date.

This transaction is entirely voluntary. You cannot be required to sign the attached foreclosure agreement.

This voluntary foreclosure agreement will become final unless you sign and deliver or mail this notice of cancellation to __________________ before midnight of __________________ (name of mortgagee) (enter proper date).

I HEREBY CANCEL THIS TRANSACTION. ______________________________ _____________________________________ DATE SIGNATURE"

•

VFA does not work against feds and questionable but more likely than not should work against state liens (preemption)

•

VFA needs statutorily compliant agreement and waivers for debtors (4 business days not counting holidays to rescind executed VFA)

•

Once VFA signed and filed, secured creditor can send redemption notice to junior lien, judgment and mortgage holders and require payment in full in sixty (60) days

•

Should get VFA and quit claim deed from debtor because some title companies errantly claim a VFA is not a title shifting document

•

VFAs have worked to clean up multimillion dollar junior lien positions and force junior position holders to put up or get stripped off the title to the VFA described real estate

•

VFA applies to debtor indebtedness but only strips off real estate, not UCC lien positions but if indebtedness gone the liens are subject to a SDCL 44-3-8 challenge/liability 44-3-8. Satisfaction of lien--Execution of discharge or release by holder--Damages for failure to execute and deliver satisfaction--Attorney fees--Additional penalty. Whenever any mortgage, pledge, or other lien of any kind has been satisfied either by payment, foreclosure, or other legal means, the holder of such lien shall, within thirty days of satisfaction, deliver a sworn satisfaction to the debtor. However, immediately upon satisfaction of a lien or at any time thereafter, if the owner of the property makes written demand on the lienholder, the lienholder shall, within ten days of receipt, execute and deliver to the debtor a sufficient sworn satisfaction to cancel the lien or any record thereof. If the lienholder fails to execute and deliver to the owner of the property a sworn satisfaction within ten days of receipt of a proper written demand, the owner of the property is entitled to recover from the person who failed to comply with the provisions of this section all damages that he or she may have sustained thereby, including attorney's fees and an additional penalty in the sum of one hundred dollars.

V.

BANKRUPTCY - THE GOOD, THE BAD AND THE UGLY

•

CHAPTER 12 VS. 11 - $4.135 Million is the statutory limit - see In re Tacke (Judge Nail, 2018 decision granting creditor motion to dismiss due to farmer exceeding statutory debt limit)

•

mediation is much cheaper than bankruptcy for creditor and debtor

•

In either Ch. 11 or 12, fully secured creditor entitled to principal, interest and attorney fees BUT interest is a Till situation where you are typically entitled to 1-3 percent above prime rate at time debtor(s) file - typical rate is 1-2 over prime and to fight you would need an evidentiary hearing with witnesses and likely experts re: the rate at time of loan versus current market conditions

•

Ch. 11 has far more trustee fees and far less flexibility and more cost than a 12

•

payments in an 11 or 12 confirmed plan can be for not just five years as maximum but many more if approved

•

chart your deadlines and follow the rules

•

go to the 341s in most cases, particularly where you need information or have questions client reps can go instead of counsel but both typically best practice

•

get your proof of claims in timely or get run (Bank 360 nightmare in IA)

•

motions for cash collateral are typical fare and usually approved - hard to challenge and prevail as creditor (In re Tyler McGregor - Judge Nail bench decision on math wrong so preliminary use of cash collateral denied, requiring eventual dismissal)

•

motions to dismiss are frequently frowned upon unless there is real go to the show and unless there debtors have filed in bad faith/serial or repeat filers in condensed time frame or there are law enforcement or other ugly factors in play

YOU ARE RIGHT ON THE CONCLUDING OBLIGATORY EASTWOOD (GOOD, BAD AND UGLY) PHOTO BUT WHICH EASTWOOD PHOTO WILL BE USED....????

NOT EVERYTHING IS AS YOU WOULD NORMALLY ASSUME GO FORTH AND DO WELL. THANK YOU FOR YOUR TIME AND THE STORE IS OPEN FOR BUSINESS (Q&A)

1

Laura L. Kulm Ask Laura L. Kulm Ask is a partner at the law firm of Gerry & Kulm Ask, Prof. LLC, in Sioux Falls, South Dakota where she practices in the areas of bankruptcy, corporate law, and estate planning. Mrs. Kulm Ask received her bachelor of science degree (cum laude) from the University of South Dakota in 2000 and received her juris doctorate degree from the University of South Dakota in 2003. Mrs. Kulm Ask is admitted to the United States Court of Appeals, 8th Circuit; the U.S. District Court of South Dakota; and the South Dakota Supreme Court. Mrs. Kulm Ask is a member of the State Bar of South Dakota; the American Bar Association; the Second Judicial Circuit Bar Association; the National Association of Consumer Bankruptcy Attorneys; the South Dakota State Bar Debtor/Creditor Committee; and the U.S. Bankruptcy Court, District of South Dakota, Local Bankruptcy Rules Committee.

How To Manage the Trenches During the Farm Crisis Laura L. Kulm Ask Gerry & Kulm Ask, Prof. LLC.

2

Sioux Falls, SD

A. B. C. D. E. F.

G. H.

Commodity prices are low and volatile Real estate is staying stable in most places Machinery/equipment prices were low but are slightly improving Interest rates on loans are going up Costs for farming are increasing Lending institutions are getting nervous and not lending much in the agricultural world Have other lending that is infiltrating the agricultural world which is not always good Bad impact on the farmers: health, divorce, stress, suicides, all as covered later

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

A.

Informal Resolutions 1. Mediation – SDCL §54-13 a. It is MANDATORY. (SDCL §54-13-10) b. A creditor MUST mediate with the farmer BEFORE taking any of the following actions against agricultural land or property: 1. commencing an action or a proceeding to enforce a debt totaling over $50,000.00 or more, OR 2. foreclosing (even DIL or QCD), OR 3. enforcing a secured interest, OR 4. pursuing any other action, proceeding or remedy.

c. NO creditor may commence any action OR proceeding until a release is granted, or farmer waives the mediation, or until a court determines that the delay would cause creditor to suffer “irreparable harm” d. EXCEPTION – irreparable harm to creditor is the only exception to mandatory mediation and there are restrictions with that.

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

A.

Informal Resolutions (cont.)

2. Must mediate in good faith (ARSD 12:20:01:11)

3. Not a “jump through the hoops” process 4. Have your farmers ALWAYS request an agricultural financial consultant during the mediation process.

5. Advise your farming clients to ALWAYS take advantage of the mediation session and come prepared to workout an agreement – do NOT advise them to waive mediation.

6. Informal workouts / Negotiations a. Similar to formal bankruptcy b. Similar to plan terms, and sometimes better terms than a creditor would get in bankruptcy c. Quicker and more efficient and more cost effective d. Easier to get accomplished with willing parties

e. Informal workout can happen at any time

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

B. Formal Resolutions 1. Chapter 12 bankruptcy a. The Bankruptcy Court reports that more chapter 12 cases have been filed so far in 2018 than in any full year since 1999. b. Secured creditors = paid secured portion of claim c. Can strip off a portion or all of secured creditor lien d. Unsecured creditors = get net disposable income for 5 years and the rest is discharged e. Can not have total debt that exceeds $4,153,150* * this needs to be increased with the current size of farms and the current costs of farming 2. Agricultural Chapter 11 bankruptcy a. Farmers with total debt exceeding $4,153,150 b. More complex and time consuming than Chapter 12 c. Therefore, more expensive than Chapter 12

d. Longer process for both farmers and creditors 3. Important - if you can avoid a bankruptcy filing, do it. It is usually better for the creditors and the farmers to avoid the filing.

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

A.

Don’t let farmers set up too many entities to run their operations

B.

Have farmers hold checks from sale of grains, cattle, etc. until workout completed in writing with bank

C.

Hold off on sale of collateral until workout put in writing including a full agreement on restructuring of remaining debt – don’t let your clients liquidate or partially liquidate with a “promise to work things out afterwards”

D.

Advise your clients to review and correct financial statements done with bank to make sure accurate before signing 1. Make sure to tell them to list only their assets on those, and their actual ownership interest in assets 2.

Make sure that they correct old machinery lists or correct head counts on livestock that are outdated

3.

Make sure that they don’t have leased assets or leased debts on them unless properly marked as such

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

A.

Dischargability of capital gains tax change 1. 11 U.S.C. §1232 2. Applicable to Chapter 12 bankruptcies only 3. Effective as of 10/26/2017 4. Farmer can discharge any unsecured tax that arises: a. Before the filing of the bankruptcy OR b. After the filing of the petition but before the discharge, c. As long as it results from the sale of property.

5. Treated as unsecured claim and discharged under §1228

B.

Cap on debt for Chapter 12 needs to increase 1. In chapter 12 – total debt can not exceed $4,153,150 2. Agricultural Chapter 11 is the next option if over

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

A.

Farming is not an occupation, it's a way of life. A farmer doesn't go to his/her job to farm, it's part of who they are. Therefore, telling a farmer to sell his/her land to pay off their debts is like telling them to cut off a body part, or even worse, to end their life.

B.

Death and/or major illnesses from stress

C.

Divorces

D.

High suicide rates 1. It has been said that farmers and ranchers already have the highest suicide rates of any occupation which is completely understandable considering you spend thousands to millions of dollars on a hope and a prayer in an attempt to continue to feed this country.

2. price volatility, extreme weather, isolation, long hours, lack of mental health care in rural areas, lack of sleep, etc.

E.

It is our ethical job to keep our eyes open for these things and do the right thing when advising either our creditor clients or farming clients.

__________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________ __________________________

The Impact of the TCJA on Agricultural Producers September 28, 2018

Contact ktidgren@iastate.edu www.calt.iastate.edu @CALT_IowaState

2

1. MANY CHANGES ARE TEMPORARY. 3

Center for Agricultural Law & Taxation

Individual Issues 4

Center for Agricultural Law & Taxation

Lowered Individual Tax Rates • •

Most agricultural businesses operate as sole proprietor or pass-through business.

From 2018 through 2025, the Act lowers individual tax rates across the board.

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Center for Agricultural Law & Taxation

Increased Standard Deduction •

Of the roughly 143 million tax filers in the U.S., about 48 million itemize deductions.

• The Act will significantly decrease that number by eliminating many itemized deductions and increasing standard deduction.

• For 2018 through 2025, the Act increases the standard deduction to $24,000 for married filing jointly, $12,000 for single taxpayers, and $18,000 for head of household.

• The additional standard deduction for the aged or blind continues at $1,300 in 2018.

6 Center for Agricultural Law & Taxation

Suspended Personal Exemptions •

The Act suspends the personal exemption from 2018 through 2025.

• The personal exemption was $4,050 for each taxpayer and dependent in 2017.

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Center for Agricultural Law & Taxation

Eliminated Many Itemized Deductions Miscellaneous Itemized Deductions Subject to the 2% Floor, including: • Unreimbursed employee expenses (including, home office expenses, uniform expenses, travel expenses, meals & entertainment expenses, license fees, tools used for work, and job search expenses) • Tax preparation expenses • Safe deposit box rental • Hobby expenses • Investment fees and expenses 8

Center for Agricultural Law & Taxation

Unreimbursed Employee Expenses •

Hits certain types of employees hard: • Truckers • Salespeople • Employees with a home office

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Center for Agricultural Law & Taxation

State & Local Taxes •

Individual taxpayers can now claim as an itemized deduction only an amount up to $10,000 ($5,000 for married filing separately) per year for state and local income taxes and/or property taxes paid during tax years 2018 through 2025 (Schedule A). • Property taxes incurred in a trade or business continue to be fully deductible on a Schedule C, Schedule E, or Schedule F. 10

Center for Agricultural Law & Taxation

Charitable Contributions •

Largely unchanged, but with increase in standard deduction and loss of many itemized deductions, many charitable contributions will no longer result in a tax deduction.

• The Act does not change the ability of those over 70 1/2 to make qualified charitable distributions from an IRA, without including those distributions in income.

• The Act does not change the ability of farmers to make a charitable contribution of commodities without including those distributions in income.

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Center for Agricultural Law & Taxation

2. CHILDREN ARE GOLD PLATED. 12

Center for Agricultural Law & Taxation

Child/Dependent Tax Credit •

•

•

Through 2025, increases child tax credit to $2,000 (up from $1,000).

• Applies to children under 17 years.

• New: $500 nonrefundable credit for other qualifying dependents.

Qualifying income amounts are significantly increased ($400,000 for MFJ instead of $110,000 to begin phase-out). $1,400 is refundable 13

Center for Agricultural Law & Taxation

3. THE NEW LAW DID NOT FIX THE HEALTH CARE PROBLEM. 14

Center for Agricultural Law & Taxation

Healthcare Mandate •

•

The Act sets the Individual Shared Responsibility Payment to $0, beginning in 2019, meaning that individuals who do not have health insurance in 2019 and later will not be liable for the penalty.

The penalty remains in place for tax years 2017 and 2018.

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Center for Agricultural Law & Taxation

Kiddie Tax •

•

Old law: Earned income of children taxed at individual rates and unearned income (exceeding $2,100) was taxed at parent’s rate if that rate was higher.

New law: Unearned income (exceeding $2,100) is now generally subject to trust and estate rates.

16

Center for Agricultural Law & Taxation

Kiddie Tax •

Applies to full-time students under the age of 24 or to any children through age 18.

• Applies only if earned income does not exceed 50 percent of support.

• Scholarships don’t count.

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Center for Agricultural Law & Taxation

Meals & Entertainment •

•

Tax Cuts and Jobs Act disallows business deduction for entertainment expenses.

• Prior to act, there was 50 percent deduction if such an expense was directly related to business.

• How that applies to meals is unclear.

Guidance is needed.

Meals consumed while on business travel continue to be 50 percent deductible.

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Center for Agricultural Law & Taxation

What do we know?

Expense

Pre-TCJA

Client-Related Business Meals

•

50%

•

? (0 or 50)

Employer-Provided Business Meeting Meals

•

50%

•

50%

•

100%

•

Probably 50%

•

100%

•

Probably 100%

•

50%

•

50%

Employer-Provided Coffee, Tea, snacks, etc.

Employee Holiday parties Work-Travel Meals

2018

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Center for Agricultural Law & Taxation

Meals for Convenience of Employer •

•

•

Meals for the convenience of employer are now 50 percent deductible and will be 0% deductible after 2025.

Should continue to be excluded from employee’s income under IRC § 119(a) if Treas.

Reg. § 1.119-1(a)(2)(ii) conditions are met.

Note that if the meals are not excludable from income, expense is deductible as compensation.

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Center for Agricultural Law & Taxation

4. THE ESTATE PLANNING LANDSCAPE HAS CHANGED…AGAIN…FOR NOW.

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Center for Agricultural Law & Taxation

Estate Tax Provisions •

• •

• •

Doubled the basic exclusion to $11,180,000 per person for estate and gift and generation skipping tax. $15,000 annual exclusion retained.

Portability Retained Basis Adjustment Retained Basic exclusion amounts reset to pre-Act levels in 2026.

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Center for Agricultural Law & Taxation

Estate Tax & Generation Skipping Tax In 2016, there were 5,219 estate tax returns filed for taxable estates.

• Only 682 taxable estates had any farm property in 2016 (2% of total taxable assets) • Now estimated that number will be around 1,800.

• Big need to plan for disability, farm transition, capital gain tax, etc. And increased exclusion is not permanent.

23 • GST planning necessary •

•

Center for Agricultural Law & Taxation

What about a clawback?

•

If gift is given during lifetime while higher exclusion amount is in place, but giver dies when exclusion is lower, is there a clawback?

• Appears that Congress did not intend a clawback, but IRS is tasked with writing regulations to define how process would work.

• Computation of estate and gift taxes to reflect changes in basic exclusion amount is on list for priority guidance.

24

Center for Agricultural Law & Taxation

What about portability? • •

Existing regulations would apply DSUE in place at time of first spouse to die.

This perhaps makes portability election more, not less, important. Would (in the absence of contrary guidance) lock in the higher amount of exclusion for future years, even if exclusion decreases.

25

Center for Agricultural Law & Taxation

Key Business Provisions 26

Center for Agricultural Law & Taxation

Corporate Income Tax Rate • •

Permanently lowers the maximum corporate tax rate from 35% to 21%, beginning in 2018.

Fiscal year C corps apply a blended rate (between old rate and new rate), based upon IRC §15.

• Confirmed by IRS Notice 2018-38 (4/16/2018)

27

Center for Agricultural Law & Taxation

5. IT’S NOT A RATE CUT FOR EVERYONE. 28

Center for Agricultural Law & Taxation

Corporate Tax Rate – Now a Flat Rate • •

Small corporations may consider conversion to S Corporation in light of new law.

Many see a rate increase.

• Old Rates:

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Center for Agricultural Law & Taxation

NEW IRC ยง 199A DEDUCTION 30

Center for Agricultural Law & Taxation

6. THERE’S NOTHING SIMPLE ABOUT IT. 31

Center for Agricultural Law & Taxation

New IRC § 199A Deduction 20 percent deduction (subject to many limitations) • Applies to “qualified business income” received by an individual from a pass-through business: LLC (not taxed as a C corporation) • S Corporation • Partnership • Sole Proprietorship • Trusts • Agricultural & Horticultural Cooperatives •

•

Tries to even the playing field for pass-throughs, making the highest effective rate 29.6%.

32

Center for Agricultural Law & Taxation

New IRC ยง 199A Deduction โ ข

Unlike corporate tax rate provision, IRC ยง 199A deduction is in effect only from 2018 through 2025.

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Center for Agricultural Law & Taxation

Qualified Business Income •

•

The net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.

QBI does not include wages, reasonable compensation, guaranteed payments, non-business interest income, non-business annuity income, dividend income, or capital gain. IRC § 199A(e)(4).

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Center for Agricultural Law & Taxation

Qualified Business Income • •

Must be effectively connected with a U.S. trade or business.

There is a separate calculation for each “qualified trade or business.”

• New regulations allow taxpayers to aggregate related trades and businesses to maximize deduction.

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Center for Agricultural Law & Taxation

U.S. Trade or Business Proposed § 1.199A-1 states that for purposes of 199A, IRC § 162(a) provides the most appropriate definition of “trade or business.”

• IRS notes that the definition is “derived from a large body of existing case law and administrative guidance interpreting the meaning of trade or business in the context of a broad range of industries.”

• Question exist about rental income (discuss later) •

Center for Agricultural Law & Taxation

Exclusions from QBI •

• •

• • • •

•

REIT Dividends / PTP Income (Special Deduction) Wages, Salaries, and Guaranteed payments Dividends Interest (unless allocable to trade or business) Capital gains and losses Annuity Income Income NOT effectively connected with a U.S. trade or business I.R.C. §1231 gains and losses (when treated as capital) Center for Agricultural Law & Taxation

6A. INCOME THRESHOLDS ARE KEY FOR QBI DEDUCTION! 38

Center for Agricultural Law & Taxation

Calculating the QBI Deduction •

If your taxable income is below $315,000 for MFJ or $157,500 for singles: • the new 199A deduction for QBI is the LESSER of: • 20 percent of QBI OR • 20 percent of (taxable income – net capital gain)

39

Center for Agricultural Law & Taxation

Limitations on QBI Income management becomes important (below threshold, only taxable income limit applies!)

Center for Agricultural Law & Taxation

Income Below Threshold • •

James, single Taxable income = $100,000 ($44,000 wages, $68,000 in QBI from farming operation, minus $12,000 standard deduction) 199A Deduction = • Lesser of: • .20 * $68,000 = $13,600 OR • .20 * $100,000 = $20,000 = $13,600 James’ taxable income will be $86,400.

41

Center for Agricultural Law & Taxation

Specified Service Trade or Business Limitation (Not QBI) SSTB • Health (including veterinarians) • Law • Accounting • Actuarial Science • Performing Arts • Financial Services • Brokerage Services • Consulting

NOT SSTB • Engineering • Architecture • Sales of pharmaceuticals • Real estate agents and brokers • Insurance agents and brokers • Property management • Taking deposits and making loans Center for Agricultural Law & Taxation

Specified Service Trade or Business Limitation SSTB limit does not apply if income is below threshold.

• SSTB limit is phased in over next $50,000/$100,000.

• If income above phase-in, no deduction for SSTB (income is not QBI).

•

Center for Agricultural Law & Taxation

Taxable Income Not > Threshold - SSTB

Center for Agricultural Law & Taxation

Taxable Income Not > Threshold - SSTB QBI deduction is lesser of: • .20 ($125,000) = $25,000 (20% of QBI) • .20 ($134,169) = $26,834 (20% of taxable income minus capital gain)

Center for Agricultural Law & Taxation

Taxable Income Not > Threshold

Center for Agricultural Law & Taxation

SSTB— Taxable Income Exceeds Phasein Range See what a difference income level makes.

Center for Agricultural Law & Taxation

W-2 Wage / Property Limitation Does NOT apply if income is equal to or less than threshold ($157,500 / $315,000 (MFJ)).

• Phased in over next $50,000 / $100,000.

• Fully applies if income above phasein ($207,500 / $415,000) • Applies separately to each trade or business (unless aggregated) •

Center for Agricultural Law & Taxation

W-2 Wage / Property Limitation If it applies, the W-2 wage / property limitation limits the QBI deduction to the greater of: • 50% of W-2 wages paid by a qualified trade or business or • 25% of the W-2 wages plus 2.5% percent of the unadjusted basis of qualified property immediately after acquisition (UBIA).

Center for Agricultural Law & Taxation

W-2 Wages Wages as defined in I.R.C. § 3401(a) (withholding statute).

• Elective deferrals as defined in I.R.C. § 402(g)(3) • Deferred compensation •

•

Includes compensation deferred under I.R.C. § 457, and the amount of any designated Roth contributions. Includes items on Form W-2, such as health insurance for employees (including S corporation shareholders).

Center for Agricultural Law & Taxation

W-2 Wages Does not include guaranteed payments. • Does not include amounts not property included on timely-filed SSA return. •

Center for Agricultural Law & Taxation

W-2 Wages W-2 wages regulations like those for DPAD, except limitation applies separately for each trade or business.

1. Determine total wages paid 2. Allocate among trade or businesses 3. Allocate to QBI 4. Allocate among partners, etc.

Center for Agricultural Law & Taxation

Excluded from “Wages” Commodity wages (I.R.C. § 3121(a)(8)(A)) • Children under 18 employed by parents for agricultural labor (I.R.C. § 3121(b)(3)(A) – not “employment,” so not “wages”) • Helpful for coop provision, not helpful if income above threshold.

•

Center for Agricultural Law & Taxation

UBIA of Qualified Property The QBI deduction is limited to the greater of • 50% of the W-2 wages with respect to the qualified trade or business; or • 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of all qualified property.

Center for Agricultural Law & Taxation

UBIA Generally, unadjusted basis = cost basis of property immediately after acquisition • No deductions for depreciation or improvements • No deductions for AFYD or Section 179 • Inherited = FMV at death • Must be reduced for personal use

Center for Agricultural Law & Taxation

UBIA – S Corporation •

If property is contributed to S corporation by shareholder (I.R.C. § 351 transfer in exchange for stock), S Corp. takes property with UBIA = adjusted basis in hands of shareholder.

Center for Agricultural Law & Taxation

Qualified Property •

Tangible and depreciable property held by and available for use in qualified trade or business at close of tax year.

• Must be used in production of QBI. • Assets sold before year-end are not qualified property.

Center for Agricultural Law & Taxation

Qualified Property Depreciable Period “Depreciable period” (MACRS rules) of property must not have ended before the close of the tax year.

• But, if MACRS period is less than 10 years, depreciable period = 10 years from date first placed in service.

•

Note: May no longer show up on depreciation schedule, must add back.

Center for Agricultural Law & Taxation

Qualified Property Depreciable Period Example • •

Taxpayer acquired and placed into service in farming business $250,000 combine in 2009.

Although 7-year MACRS depreciation has ended before close of 2018 tax year, depreciable period is 10 years (which has not ended at close of 2018) since combine is still in use for generation of QBI.

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Center for Agricultural Law & Taxation

Allocation Among Shareholders / Partners Partner and shareholder allocable share of UBIA is determined by pro rata share of depreciation.

• But, if no longer depreciating, •

•

Partner = IRC § § 704(b) and 704(c) allocation if qualified property were sold in hypothetical transaction S corp Shareholder = share of UBIA proportionate to ratio of shares held by shareholder to total shares.

Center for Agricultural Law & Taxation

Like-kind exchange or involuntary conversion •

Date replacement property is placed in service is separated: • Substituted basis is deemed placed in service on the day the relinquished property was placed in service. • Any excess basis is deemed placed in service on date replacement property is placed in service.

Center for Agricultural Law & Taxation

Example Placed in service - January 5, 2012 = $1,000,000 cost basis • December 31, 2018 – Adjusted basis = $821,550 • UBIA for 2018 = $1,000,000 •

Center for Agricultural Law & Taxation

S Corporations & Partnerships Deduction is taken at the partner or shareholder level. Entity must allocate: • Income and loss • W-2 Wages • Allocated in same manner as pro rata share of wage expense • UBIA of Qualified Property

Center for Agricultural Law & Taxation

6C. AGGREGATION IS IMPORTANT TOOL 64

Center for Agricultural Law & Taxation

Aggregating Entities • •

•

•

Compute QBI for each separate trade or business Group to use wages and UBIA of one trade or business to increase QBI for second Combining the two could increase the QBI deduction.

Aggregation is allowed, but not required.

Center for Agricultural Law & Taxation

Aggregation Prop. Treas. Reg. 1.199A-4 requirements:

Each trade or business must be a trade or business (exception for self-rentals) 2.

Same “person or group� must directly or indirectly own a majority interest in each of the businesses to be aggregated for a majority of the year 3.

None of the trades and businesses can be SSTBs. T or B must have same tax year 1.

Center for Agricultural Law & Taxation

Attribution •

Individual is considered as owning the interest owner directly or indirectly by his or her spouse, children, grandchildren, and parents.

Center for Agricultural Law & Taxation

Aggregation Must meet two of the following three factors: 1.

2.

3.

The businesses provide products and services that are the same or that are customarily provided together (i.e. a gas station and a car wash) The businesses share facilities and significant centralized business elements such as personnel, accounting, or human resources The businesses are operated in coordination with, or reliance on, other businesses in the aggregated group

Center for Agricultural Law & Taxation

Aggregation • • •

•

Minority owners can aggregate, as long as same group owns majority of each t or b Different owners can aggregate different t or bs Once you choose to aggregate, you must continue to report consistently in future years • But if eligibility ceases, so does ability to aggregate All aggregation elections are made at individual, not entity level 69

Center for Agricultural Law & Taxation

Aggregation •

•

•

These aggregation rules are separate and apart from the grouping rules for IRC § 469, which IRS deems “inappropriate” for the 199A deduction.

Section 469 is a loss limitation rule intended to prevent taxpayers from sheltering losses with non-passive income.

Section 199A is “not based on the level of a taxpayer’s involvement in the trade or business (both active and passive owners of a trade or business may be entitled to the deduction).”

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Center for Agricultural Law & Taxation

Aggregation •

For taxpayers with income above the threshold, • Usually beneficial to aggregate to maximize W-2 wages.

• When aggregating, deduction is calculated using combined QBI, W‐2 wages and UBIA.

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Center for Agricultural Law & Taxation

Example – Disregarded Entities •

John owns cattle and grain businesses.

• Centralized purchasing, transportation, and accounting operations • Operated in reliance on one another • Can aggregate and treat as a single trade or business

Center for Agricultural Law & Taxation

Example – Partnerships •

John, Brian, Cathy, Diane own 25 percent of each of two partnerships.

• They are unrelated.

• Because the four partners together own more than 50 percent of capital and profits in each partnership, they qualify to aggregate.

Center for Agricultural Law & Taxation

Self-Rentals •

Solely for 199A, prop. regs provide that rental of tangible or intangible property to related trade or business is treated as trade or business if they are commonly controlled.

Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

• •

Proposed regulations did little to clarify “trade or business” questions with respect to rental activities.

Must be IRC § 162 trade or business.

There is no bright-line definition of what types of rental activities constitute trades or businesses for purposes of IRC § 162. The courts make trade or business determinations on a case-bycase basis after a highly factual inquiry.

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

Best “definition” for an IRC § 162 “trade or business” is the most recent guideline from the U.S. Supreme Court: • To be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity. Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987). A sporadic activity, a hobby, or an amusement diversion does not qualify. Id. 76

Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

Resolution of this issue "requires an examination of the facts in each case." This may be thought by some to be a less-thansatisfactory solution, for facts vary. (quote from S. Ct.)

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

Courts have long recognized that the distinction between ownership and management of real property and of securities is significant in determining what constitutes a "trade or business." See Curphey, 73 T.C. at 774; Rogers v. United States, 69 F. Supp. 8, 12 (D. Conn.

1946).

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

“In the final analysis, the issue is ultimately one of fact in which the scope of the ownership and management activities may be an important consideration.” The activities must be sufficiently systematic and continuous to “place the owner in the business of real estate rental.”

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

•

Good v. Commissioner, 16 TC 906 (1951), acq., 1951-2 C.B. (20-acre pasture rental was trade or business of the taxpayer, not a capital asset; taxpayer owned 310 acres of additional farm property.)

Anderson v. Commissioner, TC Memo 1982-576 (Nurse-anesthetist who tried to claim §280A home office deduction first for medical work and, alternatively for 80-acre farmland rental, was denied. Did not prove rental was a trade or business.)

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI • •

•

Durbin v. Birmingham, 92 F. Supp. 938 (S.D. Iowa 1950) Iowa banker owned land in Colorado. Leased from 1908 to 1942 to various individuals on a crop sharing contract, with no personal control or management exercised on the part of Mr. Durbin over such farming operations.

Received “small amounts of income” from land. No deductions were taken.

81

Center for Agricultural Law & Taxation

Farm Lease Income & QBI • •

Land ultimately sold at a loss for unpaid taxes (while banker was alive).

IRS said trade or business/ordinary loss, but widow prevailed in argument that it was capital asset held for the production of income.

82

Center for Agricultural Law & Taxation

Farm Lease Income & QBI • •

Meinhardt v. Commissioner, 766 F.3d 917 (8th Cir. 2014) Taxpayers owned 420 acres of farmland and a farmhouse. They cash rented the farmland, but did not lease the old farmhouse. Instead, they improved the house and allowed family members to live in the house from time-to-time,

83

Center for Agricultural Law & Taxation

Farm Lease Income & QBI โ ข

Court denied an IRC ยง 162 deduction related to the farmhouse because the taxpayers "treated the farmhouse separately from the leased farmland, which was admittedly a business activity, and therefore expenses related solely to the farmhouse could not be deducted as ordinary and necessary expenses of the leased farmland activity."

84

Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

• •

Morehouse v. Commissioner: Tax Court said that petitioner engaged in the trade or business of participating in the CRP and managing his CRP properties with the primary intent of making a profit.

8th Circuit reversed by calling it rent (taking away the t or b question) Morehouse v. Commissioner, 769 F.3d 616 (8th Cir. 2014), rev'g 140 T.C. 350 (2013).

• IRS AOD: continue to litigate its position, even with respect to taxpayers in the Eighth Circuit where payments were made after 2008.

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Center for Agricultural Law & Taxation

Farm Lease Income & QBI •

•

Example 1 on page 119 of proposed regulations suggests that rental of bare land can rise to the level of a trade or business.

The example depicts an individual owning several parcels of land and leasing them to several suburban airports for parking lots. It is assumed in the example that the rental is a trade or business, even though the rental includes no depreciable property. It is the management of the parcels that is the trade or business.

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Center for Agricultural Law & Taxation

When is Farm Lease Income QBI? • •

•

Materially participating lease – yes (trade or business of farming) CRP – IRS still holds to position that CRP income is T or B, if owner has some management activity (personally or through an agent) Crop Share or Cash Rent: Must have activity other than collecting a check • Unknown where that line will be drawn • Final regulations may provide more guidance 87

Center for Agricultural Law & Taxation

7. THE COOP DEDUCTION PUT THE MIDWEST ON THE MAP FOR A WHILE.

88

Center for Agricultural Law & Taxation

DPAD •

•

•

Implemented in 2005, the IRC § 199 deduction climbed to 9 percent for tax years 2010 and later.

Deduction was lesser of: • 9 percent of taxable income from qualified production activities income (QPAI) or • 50 percent of W-2 wages or • 9 percent of taxable income Corporations and individuals qualified for DPAD. 89

Center for Agricultural Law & Taxation

DPAD and Cooperatives •

•

•

Beginning with some favorable private letter rulings in 2008, coops began characterizing patrons’ sales as per unit retains paid in money (PURPIM).

Patron would get a 1099-PATR reporting the sale.

Cooperatives could include PURPIM in calculating its own DPAD and choose to pass through whatever percentage it chose.

• Helpful for farmers without wages • Many cooperatives passed through

90

Center for Agricultural Law & Taxation

DPAD Repealed • •

IRC § 199 was permanently repealed beginning in 2018.

Congress said it was no longer needed in light of lower corporate tax rates and new 199A deduction.

91

Center for Agricultural Law & Taxation

Qualified Cooperative Dividends •

Special provision was added into the law at the last hour.

92

Center for Agricultural Law & Taxation

Qualified Cooperative Dividend •

As written, generally favored sales to cooperatives by members over sales to noncoops or sales by non-patrons. (20 percent of gross, rather than 20 percent of net).

93

Center for Agricultural Law & Taxation

Qualified Cooperative Dividends Non Coop • $200K sales • $150K expenses $50K net income Deduction is lesser of: 20 percent of $50K = $10K OR (2) 20 percent of $50K$12K = $38K *.20 = $7,600 Final Taxable Income = $30,400

Coop Sale by Member • $200K sales • $150K expenses $50K net income Deduction is lesser of: 20 percent of $200K = $40K OR 100 percent of taxable income = $38K Final Taxable Income = $0 Center for Agricultural Law & Taxation

95

Center for Agricultural Law & Taxation

Consolidated Appropriations Act, 2018 Provided Fix (March 2018) •

Those not selling to cooperatives continue to calculate 20% QBI deduction (net income)(limited to 20 percent of taxable income minus capital gain).

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Center for Agricultural Law & Taxation

DPAD is Reintroduced (Without the Name) •

Patrons selling to cooperatives must calculate 20% QBI deduction, then subtract lesser of: • 9% of net income attributable to coop sale or • 50 percent W-2 wages attributable to sale • Note if they pay no wages, there is no reduction (20% QBI deduction) • Those who pay wages typically get only an 11% QBI deduction •

BUT ALSO…

97

Center for Agricultural Law & Taxation

Coops Can Take “New DPAD” •

•

IRC § 199A(g) reintroduces DPAD, although it’s not called that.

This allows coops to take a deduction equal to 9 percent of qualified production activities income (income-expenses). This deduction, however, is limited to 50 percent of W-2 wages paid.

98

Center for Agricultural Law & Taxation

“New DPAD” •

•

•

Cooperative can choose to pass some or all of their deduction through to patrons (just like old DPAD).

This 199A(g) deduction for patrons is limited by 100% of taxable income (not subtracting capital gain).

If cooperative passes through deduction (may be up to 9% of QPAI), some farmers will get greater than 20 percent 199A deduction.

• If not, some will be stuck with 11%.

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Center for Agricultural Law & Taxation

Example – No Wages Paid $50,000 QBI ($250K grain sales – $200K expenses) • Farmer has $75,000 in taxable income because of off-farm job.

• Farmer’s final 199A deduction for 2018 is $10,000 (QBI) (no reduction because no W-2 wages) • + $2,500 (199(g)) = • $12,500 (This farmer receives a 199A deduction = 25 percent of QBI) •

100

Center for Agricultural Law & Taxation

Wages Paid • •

•

Same facts, except farmer pays $25,000 in wages.

Farmer must subtract $4,500 (9% of QBI) from $10,000 tentative deduction for a final QBI deduction of $5,500.

Farmer thus gets only an 11 percent QBI deduction in this example. However, farmer also gets to take his $2,500 199A(g) passthrough deduction from Coop, for a final 199A deduction of $8,000 (16 percent of QBI).

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Bottom Line Overall deduction may be less, more or the same if you sell to a cooperative as opposed to a noncooperative, depending upon your individual situation. (Intended to be a bit unclear so as not to excessively influence marketing decisions).

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Corporate Patrons •

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The 199A deduction, including the new 199A(g) does not apply to taxpayers that are C Corporations.

Section199A(g)(A) deduction is now restricted to "eligible taxpayers," which are taxpayers "other than a corporation." 199A(g)(2)(D).

Likewise, 199A(g)(2)(C) limits the cooperatives' own deduction only by qualified payments attributed to “eligible taxpayers.”

• What will happen with allocation?

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DPAD Transition Rules •

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Applies to farmers who receive a cooperative payment in 2018 attributable to QPAI for which the old DPAD was applicable.

• Any QPAI attributable to a cooperative tax year beginning before 2018.

These farmers (including corporations) can still take an actual DPAD deduction on their 2018 return.

• No 199A deduction will be allowed for such payments.

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2018 • •

Old DPAD, DPAD-like, and 199A deduction.

August 8 guidance did not address this subsection. Said these regulations would be coming later in the year.

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8. JUST BECAUSE YOU CAN DOESN’T MEAN YOU SHOULD. 106

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COST RECOVERY 107

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Bonus Depreciation •

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100 percent bonus depreciation through 2022, beginning with: • Qualifying property acquired and placed into service after September 27, 2017 • Also, can elect no bonus (elections cannot be revoked without IRS consent) Act provides that additional first-year depreciation (bonus) will apply to used, as well as new property.

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Bonus Depreciation •

Phase-out is as follows: • 2023: 80 percent bonus, • 2024: 60 percent bonus, • 2025: 40 percent bonus, and • 2026: 20 percent bonus.

• After that time, bonus depreciation ends.

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Section 179 •

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Beginning in 2018, the Act expanded 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 $2,030,000 in 2017).

These amounts are indexed for inflation beginning in 2019.

They are permanent.

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SUVs and Trucks > 6,000 lbs.

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100 percent bonus applies to new or used SUVs and trucks, for those vehicles purchased and placed in service after September 27, 2017. $25,000 Section 179 SUV cap is retained, but with 100% bonus in play, it’s not as impactful.

• Must be > 50 percent business use. Allocated above that amount between business and personal.

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Like-Kind Exchange •

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The Act retained IRC § 1031 like-kind exchange treatment for real property, but permanently eliminated it for personal property, beginning with exchanges occurring after December 31, 2017.

• Treated as a taxable sale and a purchase.

While increased expensing and depreciation options may offset impact, there are significant distinctions.

• State distinctives (Iowa retains 1031 this year) • SE tax/retirement considerations 112

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NEW DEPRECIATION PROVISION 113

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Farm Depreciation •

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Beginning in 2018, the Act requires new farm equipment to be depreciated over a period of five years, instead of seven years.

It also removes the requirement that this property is depreciated using the 150 percent declining balance method (except for 15 or 20year property).

• Farmers will use 200 percent declining balance method (unless elect out).

These provisions apply to property placed in service after December 31, 2017.

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9. SOME PROVISIONS MAKE YOUR EYES GLAZE OVER, BUT THEY’RE STILL IMPORTANT.

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Net Operating Losses •

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Beginning in 2018, the Act eliminates the twoyear carryback of net operating losses (fiveyears for farming businesses), but allows a twoyear carryback of net operating losses in the case of losses incurred in the trade or business of farming.

It also limits the net operating loss deduction to 80 percent of taxable income for losses incurred after December 31, 2017.

Unlimited carryforward.

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Excess Business Loss Disallowance •

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The TCJA implements an excess business loss rule that replaces (and expands upon) the excess farm loss rule (through 2025).

• Old rule: non-corporate farmers’ losses (if they received an applicable subsidy) were limited to a threshold amount of $300,000 ($150,000 for married filing separately).

Now: Non-corporate excess business loss exceeds $500,000 (MFJ)/$250,000 (single) Excess is treated as NOL. Mechanics a bit unclear pending guidance.

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Business Interest Limitation •

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Although the Act restricts business interest deductions generally to 30 percent of adjusted gross income (beginning in 2018), those restrictions do not apply to businesses with cash receipts below $25 million.

The Act also allows a farming business (as defined in IRC § 263A(e)(4)) and agricultural cooperatives to elect not to be subject to the business interest limitation. Such farming businesses, however, would then be required to use ADS for assets with recovery period of 10 years or more.

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Other Provisions •

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Expanded Cash Accounting ($25 million gross receipts for C corporations) • Partnerships with such C corporations as partners not required to use accrual method.

Farming S Corporations continue to be wholly excluded from accrual requirement, regardless of gross receipts Eliminated corporate AMT, but retained individual AMT (increased exemption amounts and phase-out thresholds) 119

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10. TAX PROFESSIONALS WILL HAVE TO CHARGE MORE THIS YEAR.

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CALT Resources 122

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www.calt.iastate.edu

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Email micki@iastate.edu

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Twitter: @CALT_IowaState

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Facebook: @centeraglawandtax

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