The Tax Cuts and Jobs Act was signed into law in late 2017. The IRS, tax preparers and taxpayers alike are all trying to figure out how the new law will affect the 2018 filing season. Two of the big changes that came from the Tax Cuts and Jobs Act include the new Section 199A deduction and the tax treatment of trades (like kind exchanges) for personal property, such as farm equipment and livestock. Below is an explanation of these two changes.
The Section 199A deduction provides for a 20% deduction of Qualified Business Income (QBI), replacing the old Section 199 (DPAD rules). Let’s take a look at some of the basics of the calculation.
- Eligible entities are sole proprietors, S-corporations and partnerships
- Reduces taxable income after Adjusted Gross Income (AGI) is calculated
- Will not reduce self-employment tax owed
- Will likely not reduce state tax owed
If taxable income is below $157,000 for single or $315,000 for married filing jointly (MFJ) taxpayers and no co-op sales are present, the calculation is fairly straight forward as follows: 199A deduction is the lesser of 20% of combined QBI OR 20% of net taxable income less capital gains.
If co-op sales are present, the calculation adds another layer of complexity: 199A deduction is the lesser of 20% of combined QBI minus the lesser of 9% of net income attributable to co-op sales OR 50% of wages paid to earn income from the cooperative OR 20% of net taxable income less capital gains.
As taxable income goes above the limits of $157,000 ($315,000 MFJ), the calculation becomes even more complicated and will need to be discussed with your tax preparer.
How can you prepare and understand how the calculation will affect your tax return?
- Percentage of co-op sales will affect the amount of deduction allowed.
- Co-ops are still able to pass through 199A deductions.
- Amount of wages paid by the qualified business can affect the deduction.
- Items that reduce taxable income like self-employed health insurance deduction, retirement deductions, HSA and standard deductions will reduce AGI and taxable income.
- Health insurance premium tax credits will need greater attention due to certain AGI limits because AGI may be higher for taxpayers in 2018. The 199A deduction is calculated after AGI compared to the old DPAD reducing AGI.
Another item that will change is how taxpayers account for trades or like kind exchanges of equipment and livestock. Previously trading an asset did not trigger taxable income. Depreciation on the traded asset simply continued with the boot eligible for current depreciation. New tax law requires reporting the trade as a sale based on the trade allowance received. In turn, the entire cost of the new asset becomes eligible for depreciation.
Let’s work through an example to obtain net income from Schedule F and Form 4797 to illustrate the differences. You’re purchasing a tractor with a list price of $300,000, and you receive a trade allowance of $150,000.
- Under 2017 law the new purchase had a basis of $150,000. ($300,000 list price less $150,000 trade allowance) Amount available for section 179 is $150,000 and no sale of equipment reported. Depreciation deduction will reduce self-employment income on Schedule F.
- Under 2018 law the new purchase beginning basis is $300,000, which is the list price. Amount available for Section 179 is $300,000. A sale of $150,000 is recorded on form 4797 of the tax return and the sale is not subject to self-employment taxes.
You may look at this table and think the new law is a better way to report the trade since you’re not paying self-employment tax but additional considerations are needed when comparing these changes.
- States like Minnesota, Wisconsin and Iowa do not conform to federal Section 179 and bonus depreciation rules, therefore a taxpayer may not be able to deduct the total cost of the new asset in one year and there will be additional taxes owed due to depreciation addback in the first year.
- If there is a loan on either tractor, you could be setting yourself up for trouble by not having depreciation deductions to offset principal payments in the future.
- Opportunities to use Schedule J for farm income averaging are reduced.
- If self-employment income is not shown year after year, Social Security benefits could be reduced when you retire.
- You may be unable to utilize your self-employed health insurance deduction. In some cases, taxpayers may also miss out on qualifying for the Earned Income Credit.
These are just a few of the changes occurring on your tax return for 2018. Tax planning and application of the new tax law will be of the utmost importance. Be prepared for changes and know that AgCountry Tax Specialists are providing the best guidance possible.