By Elizabeth Williams
DTN Contributing Editor
INDIANOLA, Iowa (DTN) -- Annual profits and losses in agriculture generally follow a rollercoaster path with sharp peaks and valleys. In the past, a tax-loss year would help farmers and ranchers offset profits from a future year.
The Tax Cuts and Jobs Act of 2017 changed that equation and limits the benefits from carrying forward net operating losses.
"The hardest part of the new tax law may be in convincing farm and ranch clients that it's okay to make a little income and pay some tax," said Rod Mauszycki, principal with CliftonLarsonAllen in Minneapolis and DTN/The Progressive Farmer's tax columnist. "If they simply build up their net operating losses as they might have done in the past, it may come back to bite them with a much steeper tax bill when they have a good year."
While the Internal Revenue Service is still finalizing some rules of how to implement the new tax law, experts like Mauszycki say there are a number of strategies farmers can use to adjust their income between the current tax year and the next tax year and make the most of tax reform.
It's just one way changes to the tax code are forcing farmers to change their mindset. In this four-part series, DTN will explain how to maximize deductions by avoiding losses, how changes to rules governing equipment trade-ins could complicate your state tax return and why it might be a good time to change your farm's corporate structure to take advantage of lower tax rates and reconsider gifting strategies.
WHY YOU WANT TO AVOID A LOSS
Under old tax rules, what were known as "excess farm losses" offset farm income without limitation. The losses could be carried forward, and because the loss went on Schedule F, it offset income subject to self-employment tax. Mauszycki said that scenario was a "win-win" for farmers.
Under the new law, an excess business loss is not deducted on Schedule F, so it does not offset self-employment income. As a result, you'll pay self-employment tax when these losses are used to offset farm income.
Tax code changes also affect non-C corporation tax payers that received a subsidy, such as USDA's Commodity Credit Corporation loans.
Previously, taxpayers who received a CCC loan were restricted in the deductibility of a farm loss. However, the disallowed portion was carried to the following year, tested again for limitation purposes and claimed on Schedule F, which helped reduce self-employment tax.
Under the new tax law, losses are now subject to "excess business loss" limitations. The net business loss is limited to $250,000 per individual or $500,000 for married couples filing jointly. These excess business losses are carried forward as part of the taxpayer's net operation loss instead of claiming the loss on Schedule F.
Starting in 2018, net operating losses will only be able to offset 80% of your taxable income, instead of the previous 100%. So, for example, if you have a substantial loss in 2018 followed by a big profit in 2019, only 80% of 2019's taxable income could be offset, assuming there were no pre-2018 net operating losses, leaving 20% subject to tax.
As for the rules themselves, previously, a net operating loss could be carried back five years. Either that, or you could elect to carry it back two years or carry it forward. Now, net operating losses can only be carried back two years, but losses can be carried forward an indefinite number of years. The carry-forward period was previously limited to 20 years.
Carrying forward a net operating loss could also reduce your Section 199A deduction for qualified business income in following years.
For example, you have a $20,000 net loss this year. You would have qualified for the 199A deduction, but can't claim it because you had no net income. Next year, your net qualified business income is $150,000. Because you carried this year's loss forward, your 199A deduction would be 20% of $130,000 ($150,000 to $20,000), or $26,000 deduction.
However, if you had no profit this year and next year you earned $150,000 in qualified business income, your 199A deduction would be 20% of $150,000, or $30,000.
"What we want essentially is little or no income. What we don't want is a loss," Mauszycki said. "This is a new way of thinking for farmers and ranchers."
STRATEGIES TO AVOID A LOSS
There are several strategies farmers and ranchers can use to adjust their income between the current tax year and the next tax year.
One of the easiest ways to keep flexibility in your tax planning is to sell grain in small increments under what are known as deferred payment contracts. Then, at tax preparation time, your tax accountant can determine which sale should be considered in the current tax year and which sale should be designated for the following tax year.
"Agriculture is the only industry that allows these deferred payment contracts," Mauszycki said.
For example, you price your grain with a deferred payment contract, and you'll receive payment on Jan. 2, 2019. The IRS gives you the option to pull that money into the current tax year, even though you don't receive payment until the next tax year, he said.
You can designate which year to recognize the sale when you prepare your tax return, and it can be made on a contract-by-contract basis. So rather than making a couple of large grain sales of $100,000 each with payment due Jan. 2, if you sold your grain in $10,000-to-$50,000 increments, you'd give yourself more flexibility at tax time to decide which sales should be designated for 2018 and which would be recognized in 2019.
"With several smaller sales, if we need additional income this year, we'll pull some of those sales into the current year," Mauszycki said.
This kind of flexibility can be important. For example, Joe Farmer typically sells the current-year crop in the following year and prepays inputs to get better pricing as well as offset taxable income. Joe sells his crop using several deferred payment contracts. He gets an unexpected deal on seed and fertilizer in December. The purchase would pull his income negative and push him out of certain credits (earned income, child credits) and increase potential issues with depreciation. However, by designating a few of the deferred payment contracts into 2018 when he does his taxes, Joe can create positive income even though he didn't receive the cash until January 2019.
Another area for flexibility at tax preparation time is deciding how to depreciate the purchases. The new tax bill makes it easier to deduct 100% of your depreciable assets in the year of purchase. However, that may not be the best tax strategy if it would reduce your income to a loss. Your tax preparer may advise depreciating the cost over the life of the asset. You may also decide to capitalize machinery repair costs.
You can also hold back on prepaid expenses if it looks like you will have a loss this year. But that decision has to be made before Jan. 1, and you may lose out on early order discounts.
As with any tax advice, especially with the complicated new tax law this year, seek expert agricultural tax counsel.
Des Keller contributed to this report.
Editor's Note: If you're interested in learning more about how to profit from tax reform and how to strengthen your financial foundation, make sure to attend the DTN Ag Summit in Chicago December 3-5. You can find all of the details at www.dtnagsummit.com
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