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Farmers and the New Tax Bill: 10 Observations
Farmers and the New Tax Bill: 10 Observations
Congress finally got its act together and passed a new tax bill on January 1, 2013, eliminating most of the fiscal cliff tax effects. Many of the bill’s provisions are favorable to farmers, but they should all be considered when planning tax strategies for 2013 and beyond.
1. Inflation-indexed estate and gift tax
Most important to long-term planning for farm families is the permanent extension of the lifetime estate and gift exemption at $5 million. The exemption is now indexed to inflation, increasing to $5.25 million in 2013. This larger exemption amount (as opposed to the original $1 million exemption for 2013) is now permanent.
“We know that permanent to Congress can mean less than a few years in some cases, so annual gift tax planning is recommended,” notes Paul Neiffer, agribusiness partner.
2. Top estate and gift tax rate of 40 percent
An offset to the permanent extension of the exemption amount is the rise in the top rate from 35 percent to 40 percent. Although higher than the old rate, the new rate is still lower than the 55 percent that would have taken effect on January 1, 2013, and lower than the 45 percent rate proposed earlier in 2012.
3. Enhanced Section 179 deduction
Section 179 deduction limits were scheduled to be $139,000 for 2012 and $25,000 for 2013. With the new bill, the maximum Section 179 deduction has been retained at the $500,000 level for tax years beginning in 2012 and 2013. The $500,000 level begins to phase-out when qualifying purchases exceed $2 million.
“Section 179 is allowed on almost all farm asset purchases (whether used or new) except for farm buildings,” notes Chris Hesse, a tax partner with CliftonLarsonAllen. “Integrated livestock feeding facilities such as a hog confinement facility can be deducted under Section 179, but not a machine shop or barn.”
“For 2014, this deduction is scheduled to revert back to $25,000, although we expect Congress to step in and increase the amount,” Hesse continues. Unlike bonus depreciation, Section 179 is based on when your tax year begins.
4. Retention of 50 percent bonus depreciation
Fifty percent bonus depreciation has been extended for any new assets purchased by December 31, 2013. Unlike Section 179, bonus depreciation applies to all new farm assets placed in service by that date. Therefore, constructing and placing a new machine shed or shop in service before January 1, 2014 will qualify for 50 percent bonus depreciation.
5. New definition of “upper income”
Almost all of the tax rates that were set to expire on January 1, 2013 were maintained. The only change is that the highest rate of 39.6 percent (up from 35 percent) is now imposed on taxable income more than $400,000 for singles and $450,000 for married couples.
6. Marriage penalty for high income earners
Due to the imbalance of higher tax rates starting at almost the same rate for married couples and singles, higher-earning couples will pay more tax than if they were not married. If two singles make $400,000 each, neither will pay the maximum tax rate. If a married couple earns $800,000, $350,000 is taxed at the highest rate. This can easily result in an increased tax liability exceeding $20,000 annually.
7. Capital gains and dividend tax rates rise
The tax bill raises the maximum long-term capital gains (and dividends) rate from 15 percent to 20 percent. However, due to the phase-out of certain itemized deductions and personal exemptions, plus the 3.8 percent net investment income tax (applied to single taxpayers with more than $200,000 in gross income, and couples with more than $250,000 of gross income), many taxpayers will see an effective maximum capital gains tax rate near 25 percent.
As an extreme example, assume a married farm couple has taxable income greater than $300,000, but less than $425,000. Their maximum capital gains rate will be about 24 percent. Multiple phase-out ranges change the effective tax rates from their stated rates.
“This is a back-door rate increase,” says Hesse. “Congress increases taxes while still advertising that the marginal rate is ‘only’ some lower amount.”
8. Permanent AMT relief
The IRS estimated that more than 25 million additional taxpayers would have been subject to Alternative Minimum Tax (AMT) in 2012 if Congress had not extended the AMT patch. The patch increases the AMT exemption to reflect the amount of inflation that has occurred between 1986 and 2012. With the new bill, Congress went one step further and made this inflation adjustment permanent.
9. Itemized deduction and personal exemption phase-out
These rules applied several years back and were scheduled to come into effect again in 2013. The only change is that Congress increased the applicable threshold levels to $300,000 for married couples and $250,000 for singles. Above these levels, 3 percent of itemized deductions will phase out, and for every $2,500 income increase, 2 percent of personal exemptions will be eliminated.
10. Planning is important
Tax planning for 2012 took an unexpected turn when Congress retroactively increased the Section 179 deduction, which is heavily used by farmers. The added deductions may reduce taxable income to a lower-than-desired level. Farmers have many tools to retroactively increase taxable income in order to compensate.
Tax planning has some certainty for this year that didn’t exist last year, but that does not mean farm families can skip it. It will require planning to steer clear of the maximum income and capital gains tax rates. Plus, farm families with a taxable estate of at least $5 million should continue using annual estate planning tools. Now is a good time to get started.
Paul Neiffer, Agribusiness Partner
firstname.lastname@example.org or 509-823-2920
Chris Hesse, Tax Partner
email@example.com or 612-397-3071