Tax Reform Action Plan
Partner in Charge of our Tax Department, Gina Cochetti, CPA, MST, and Senior Manager in our Tax Department, Tyler Willis, CPA, MST, had an article published in the Spring 2018 issue of the Coastal Grower Magazine. Read below to find out what your tax reform action plan should be.
On December 22, 2017 President Trump signed into law the Tax Cuts and Jobs Act (“tax reform”); the first significant piece of tax reform in over 30 years. This tax reform contains fundamental changes that are requiring Certified Public Accountants (CPA) and taxpayers to rewrite the tax planning playbook. Now that we are in the first year under the new law, the tasks are to understand the consequences facing taxpayers and develop strategies to achieve the best tax outcome. Specifically, what actions need taken in 2018 to ensure the best outcome for not only the current year, but future years as well.
Reassess your legal structure
Almost all types of business entities, and individuals, received a rate reduction as a result of tax reform. Corporations saw a decrease of up to 14%, while individuals and non-corporate businesses saw a more modest reduction. The highest marginal rate for individuals and non-corporate businesses is now 37%, compared to a corporate rate of 21%. Once you consider the taxation on dividends from a corporation to its shareholder, you end up with a total corporate rate closer to 40%. These differences warrant a discussion about whether your current legal structure provides the best tax outcome.
Unfortunately, there is not a “one-size-fits-all” solution or model structure. Many factors contribute to the tax impact of each option, including: cash needs of owners, life-cycle of business, plans to pay dividends to owners, ability of owners to claim 20% deduction for non-corporate entities, etc. If a change in legal entity or structure needs to be made, it is best to address it early so all necessary legal and tax compliance steps are performed.
Maximize the 20% deduction (a.k.a. the 199A deduction)
The majority of American businesses are operated as Partnerships, LLCs, S-Corporations or Sole Proprietorships. The 20% deduction for non-corporate business income was intended to provide a benefit similar to the corporate rate reduction. However, no great tax benefit comes without a few hurdles. The 20% deduction is limited based on a few factors: overall taxable income of business income recipient, classification as a “service” business, the business’s W-2 wages paid during the year, and the value of the business property. Each limitation could warrant its own article and the IRS has yet to release substantial guidance on these limitations. However, the important things to know are the existence of these limitations and the options to reduce their impact.
The hurdle we anticipate impacting the agriculture industry the most is the W-2 wage limitation. Many farmers use labor contractors and, therefore, don’t have significant W-2 wages for their farm. Depending on the overall income of the tax paying farmer, this may lead to a reduction in the 20% deduction. As a result, we expect to see more farmers moving toward employees over contractors for the purpose of increasing their W-2 wages and reducing the limitation. This is a prime example where proper planning is necessary to maximize the deduction.
In a business with multiple owners, each owner may be subject to different limitations. This may lead to options with benefits for one owner and adverse effects for the other(s). When trying to calculate the impact of this deduction for yourself, keep in mind that the deduction does not apply to income subject to self-employment taxes. The full amount is still subject to self-employment rates.
Bonus depreciation allows a business to deduct the full cost of qualifying property in the year the property begins being used in the business. This provision was included in the tax reform bill and applies to property placed in service from September 22, 2017 through the end of 2022. This provides an immediate tax benefit to taxpayers making capital investments and now applies to new and used property that is purchased. Another special provision allowed to reduce the number of years the cost of farm equipment is recovered: if you do not claim 100% bonus depreciation, the cost of farming equipment is now able to be recovered over five years.
Be cautious of big losses
A taxpayer used to be able to offset income from non-business sources (such as wages or investment income) with losses from a business the taxpayer was actively involved in. For example, during the start-up phase of a vineyard it was very common for the owner to incur significant losses and use those losses to reduce their tax from other sources of income. Now, those losses are limited to $250,000 ($500,000 if married filing jointly). This means that any losses in excess of the $250,000 threshold may not be claimed in the year incurred and must be used in a future year with sufficient income and not subject to the limitation.
An individual taxpayer has a Net Operating Loss (NOL) when their total expenses and losses are greater than the income in that year. Under the new rules, NOLs can no longer be carried back to prior years. There is, however, an exception for farm losses, which are still allowed to be carried back two years. In the year a NOL (generated after 2017) is used, it is only able to offset up to 80% of that year’s income. Due to this limitation, NOLs no longer have an expiration period.
With these new loss limitations tax professionals will be taking a more cautious approach in maximizing deductions. Rather than generating a loss that is limited and subject to future restrictions, a taxpayer is better off recognizing those losses over a number of years. Forecasting income and losses from all sources allows you to reap the maximum benefit from those losses.
Cash Method for wineries
Under the new rules within tax reform, wineries with sales under $25M have the opportunity to use the cash method of accounting and accelerate many of their deductions related to their wine inventory. The threshold prior to tax reform for wineries was only $1M, so this change makes the cash method available to a much larger share of the wine industry population. For an estate winery, the change to cash method can result in a tax deduction equal to one to two years worth of farming costs. We have seen this single change result in a deduction of over $1M for larger producers.
Start planning now
The short version of this plan, start planning with your CPA now. It can be difficult to know the most beneficial changes until you begin modeling different scenarios and changing inputs. Many of the opportunities are “use it or lose it” choices and are not always easy to implement. To avoid any surprises when it comes time to file next year, start planning now.