Monday, January 13, 2020
Over the last several posts, I have been commenting on the most important developments legal and tax developments in 2019 on farmers, ranchers, agribusiness and rural landowners. Today I am down to the two biggest developments.
The “top two” of the “top ten” – it’s the topic of today’s post.
Number 2: Year-End Tax and Retirement Legislation
In late December, the Congress passed Omnibus spending bills containing multiple parts that impact retirement provisions and disaster relief tax rules. The legislation also contains certain tax extender provisions and repeals of some of the taxes contained in Obamacare. The President signed “The Further Consolidated Appropriations Act” (H.R. 1865, PL 116-94) and “The Consolidated Appropriations Act, 2020” (H.R. 1158, PL 116-93) into law on December 20. Contained in the Omnibus legislation is the “Taxpayer Certainty and Disaster Tax Relief Act of 2019” (“Disaster Act”) which provides relief for taxpayers affected by disasters in 2018 through Jan. 19, 2020. Also included in the Omnibus legislation is the “Setting Every Community Up for Retirement Enhancement Act” (SECURE Act).
Here are the parts of the various bills that impact agriculture:
The Act passed the house on May 23, but the Senate never took it up. Nevertheless, the SECURE Act provisions did get included in the Omnibus legislation largely unmodified. The legislation represents the first major retirement legislation since the Pension Protection Act of 2006.
There are many important changes that the SECURE Act makes to retirement planning. The following are what are likely to be the most important to farm and ranch families:Here are the key highlights of the SECURE Act:
- An increase in the required minimum distribution (RMD) age for distributions from a traditional IRA from the year in which an individual turns 70.5 to the year the individual turns 72. This provision matches the existing rules for 401(k)s and Roth IRAs. The provision is applicable to persons that did not reach age 70.5 by the end of 2019. SECURE Act §114(a), amending I.R.C. §401(a)(9(C)(i)(I).
- A repeal of the rule barring contributions to a traditional IRA by persons age 70.5 and up. There was no such rule that barred post-age 70.5 contributions to a Roth IRA. SECURE Act §107(a), repealing I.R.C. §219(d)(1).
- The amount of a taxpayer’s qualified charitable distributions (QCDs) from an IRA direct to a qualified charity that are not includible in gross income for a tax year is reduced(but not below zero) by the excess of the total amount of IRA deductions allowed to the taxpayer for all tax years ending on or after the date the taxpayer attains age 70.5, over the total amount of reductions for all tax years preceding the current tax year. SECURE Act §107(b), amending I.R.C. §408(d)(8)(A). In other words, the amount of a QCD is reduced by the amount of any deduction attributable to a contribution to a traditional IRA made after age 70.5. The provision is effective for contributions made for tax years beginning after 2019 and for distributions for tax years beginning after 2019.
- Part-time employees are allowed to contribute to a 401(k) plan. SECURE Act §112(a)(1), amending I.R.C. §412(k)(2)(D).
- The legislation provides a small employer pension plan start-up credit maximum set at the greater of $500, or the lesser of $250 for each employee of the eligible employer who is non-highly-compensated and who is eligible to participate in the plan or $5,000. Secure Act §104(a), amending I.R.C. §45E(b)(1).
- The new law expands the ability to run multiple employer plans and make the process easier overall by allowing small employers to band together to set up and offer 401(k) plans with less fiduciary liability concern and less cost than presently exists. This provision is effective for plan years beginning after 2020. SECURE Act §101, amending I.R.C. §413(e) and various portions of ERISA.
Note: Under prior law, plans of different businesses could be combined into one plan, but if one employer in the multi-employer plan failed to meet its requirements to qualify for the plan, then the entire plan could be disqualified. The SECURE Act also no longer requires that members of a multi-employer plan have common interests in addition to participating in the retirement plan.
- The legislation adds a new exemption from the 10 percent penalty of I.R.C. §72(t) for early withdrawals from a retirement account. Under the provision, a parent is allowed to withdraw up to $5,000 of funds penalty-free from a 401(k), IRA or other qualified retirement plan within a year of a child’s birth or the finalization of a child’s adoption. The provision is applicable for distributions made after 2019. SECURE Act §113, amending various I.R.C. sections.
- Under prior law, funds contained in IRAs (and qualified plans) that a non-spouse inherited IRA could be withdrawn over the beneficiary’s life expectancy. Now, so-called “stretch” IRAs are eliminated by virtue of requiring non-spouse IRA beneficiaries (except for a minor child of the IRA owner, disable person, chronically ill individual, or anyone who is not more than 10 years younger than the IRA owner) to withdraw funds from inherited accounts within 10 years. Estimates are that this provision will generate at least $15 billion in additional tax revenue in the first 10 years. The provision is effective January 1, 2020. SECURE Act, §401(a)(1), amending I.R.C. §401(a)(9)(E) and (H)(ii).
Note: The provision applies to all qualified plans such as 401(k), 403(b) and 457(b) plans. It also applies to ESOPs, cash balance plans, 401(a) plans (defined contribution) as well as lump-sum distributions from defined benefit plans, and IRAs. However, it does not apply to a spousal rollover. When the owner dies, their spouse may roll over their spouse’s IRA into their own IRA.
The Congress allowed numerous tax provisions to expire at the end of 2017 and 2018. Other parts of the Omnibus legislation address some of the expired provisions, restoring them retroactively and extending them through 2020. Here’s a list of the more significant ones for farmers and ranchers:
- The provision excluding from income qualified principal residence debt that has been forgiven (up to $2 million; $1 million for married taxpayers filing separately) is restored for 2018 and 2019 and extended through 2020. R.C. §108(a)(1)(E as amended by §101(a) of the Disaster Act. The provision also applies to qualified principal residence debt discharged via a binding written agreement entered into before 2021. Disaster Act §101(b) amending I.R.C. §108(h)(2).
- The deduction for mortgage insurance premiums is retroactively reinstated and extended through 2020. This provision is extended through 2020 for amounts paid or incurred after Dec. 31, 2017. Disaster Act §102 amending I.R.C. §163(h)(3)(E)(iv)(l).
- The medical expense deduction floor is set at 7.5 percent for 2019 and 2020. Disaster Act §103, amending I.R.C. §213(f).
- The legislation restores the qualified tuition (and related expenses) deduction for 2018 and 2019 and extends it through 2020. Disaster Act §104, amending I.R.C. §222(e).
- The biodiesel fuel tax credit is extended through 2020. Disaster Act §121(a), amending I.R.C. §40A(g).
- The tax credit for nonbusiness energy property (e.g., windows, doors, skylights, roofs, etc.) for personal residences is extended for tax years beginning after 2017 and before 2021. Disaster Act §123, amending I.R.C. §25C(g)(2).
- The tax credit for electricity producer from certain “renewable” resources is extended for qualified facilities constructed before January 1, 2021. Disaster Act §127(a), amending various subsections of I.R.C. §45(d). For wind facilities the construction of which begins in calendar year 2020, the applicable credit is reduced by 40 percent. Disaster Act §127(c)(2)(A), amending I.R.C. §45(b)(5).
- The tax credit for manufacturers of energy-efficient residential homes is extended for homes acquired before January 1, 2021. Disaster Act §129, amending I.R.C. §45L(g).
- The TCJA changed the rules for deducting losses associated with casualties and disasters. The Disaster Act modifies those TCJA rules and provides that taxpayers impacted by a qualified disaster beginning January 1, 2018, and ending 60 days after the date of enactment, can make tax-favored withdrawals from retirement plans. In addition, the modification provides for an automatic 60-day filing extension of all tax deadlines for those taxpayers affected by federally declared disasters that are declared after December 20, 2019. Disaster Act §205, amending I.R.C. §7508A,
- The modification to the “kiddie-tax” contained in the Tax Cuts and Jobs Act (TCJA) is repealed effective January 1, 2020, but an election can be made to have the new rules apply to the 2018 and 2019 tax years. This means that children’s unearned income will be taxed at their parents’ highest marginal tax rate rather than the rates applicable to trusts and estates, and the taxable income of a child attributable to earned income will be taxed under the rates for single individuals. SECURE Act §501(a), amending I.R.C. §1(j)(4).
Number 1: QBI Final Regulations and QBI Ag Co-Op Proposed Regulations
In the fall of 2018, the Treasury issued proposed regulations under I.R.C. §199A that was created by the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. REG-107892-18 (Aug. 8, 2018). The proposed regulations were intended to provide taxpayers guidance on planning for and utilizing the new 20 percent pass-through deduction (known as the QBID) available for businesses other than C corporations for tax years beginning after 2017 and ending before 2026. While some aspects of the proposed regulations are favorable to agriculture, other aspects created additional confusion, and some issues were not addressed at all (such as the application to agricultural cooperatives). In early 2019, the Treasury issued final regulations and cleared up some of the confusion. Here are the main summary points of the final regulations:
- Common ownership and aggregation. The proposed provided a favorable aggregation provision that allows a farming operation with multiple businesses (e.g., row-crop; livestock; etc.) to aggregate the businesses for purposes of the QBID. This was, perhaps, the best feature of the proposed regulations with respect to agricultural businesses because it allows a higher income farming or ranching business to make an election to aggregate their common controlled entities into a single entity for purposes of the QBID. This is particularly the case with respect to cash rental entities with incomes over the QBID threshold. Common ownership is required to allow the aggregation of entities to maximize the QBID for taxpayers that are over the applicable income threshold. Treas. Reg. §1.199A-4(b). “Common ownership” requires that each entity has at least 50 percent common ownership. the final regulations provide that siblings are included as related parties via I.R.C. §§267(b) and 707(b). Including siblings in the definition of common ownership for QBID purposes will be helpful upon the death of the senior generation of a farming or ranching operation.
- Passive lease income. One of the big issues for farmers and ranchers operating as sole proprietorships or as a pass-through entity is whether land rental income constitutes QBI. The proposed regulations confirmed that real estate leasing activities can qualify for the QBID without regard to whether the lessor participates significantly in the activity. That’s particularly the case if the rental is between “commonly controlled” entities. But, the proposed regulations could also have meant that the income a landlord receives from leasing land to an unrelated party (or parties) under a cash lease or non-material participation share lease may not qualify for the QBID. If that latter situation were correct it could mean that the landlord must pay self-employment tax on the lease income associated with a lease to an unrelated party (or parties) to qualify the lease income for the QBID. Thus, clarification was needed on the issue of whether the rental of property, regardless of the lease terms will be treated as a trade or business for aggregation purposes as well as in situations when aggregation is not involved. That clarification is critical because cash rental income may be treated differently from crop-share income depending on the particular Code section involved. See, e.g., §1301.
The final regulations did not provide any further details on the QBI definition of trade or business. That means that each individual set of facts will be key with the relevant factors including the type of rental property (commercial or residential); the number of properties that are rented; the owner’s (or agent’s) daily involvement; the type and significance of any ancillary services; the terms of the lease (net lease; lease requiring landlord expenses; short-term; long-term; etc.). Certainly, the filing of Form 1099 will help to support the conclusion that a particular activity constitutes a trade or business. But, tenants-in-common that don’t file an entity return create the implication that they are not engaged in a trade or business activity.
The final regulations clarify (unfortunately) that rental to a C corporation cannot create a deemed trade or business. That’s a tough outcome as applied to many farm and ranch businesses and will require some thoughtful discussions with tax/legal counsel about restructuring rental agreements and entity set-ups. Before the issuance of the final regulations, it was believed that land rent paid to a C corporation could still qualify as a trade or business if the landlord could establish responsibility (regularity and continuity) under the lease. Landlord responsibility for mowing drainage strips (or at least being responsible for ensuring that they are mowed) and keeping drainage maintained (i.e., tile lines), paying taxes and insurance and approving cropping plans, were believed to be enough to qualify the landlord as being engaged in a trade or business. That appears to no longer be the case.
- Commodity trading. The concern under the proposed regulations a person who acquired a commodity (such as wheat or corn for a hog farm), and transported it to the ultimate buyer might improperly be considered to be dealing in commodities. This would have resulted in the income from the activity treated under a less favorable QBI with none of the commodity income eligible for the QBID for a high-income taxpayer. This is also an important issue for private grain elevators. A private grain elevator generates income from the storage and warehousing of grain. It also generates income from the buying and selling of grain. Is the private elevator’s buying and selling of grain “commodity dealing” for purposes of I.R.C. §199A? If it is, then a significant portion of the elevator’s income will not qualify for the QBID. The final regulations clarify that the brokering of agricultural commodities is not treated under the less favorable QBI provision applicable for higher income taxpayers.
I.R.C. §199A has special rules for patrons of ag cooperatives. These rules stem from the fact that farmers often do business with agricultural (or horticultural) cooperative. A farmer patron could have QBI that is not tied to patronage with a cooperative and QBI that is tied to patronage with a cooperative. The Treasury issued proposed regulations in June of 2019 on the ag cooperative QBI matter. Here are the highlights of the 2019 proposed regulations:
* Under Prop. Treas. Reg. §1.199A-7(c), patronage dividends or similar payments may be included in the patron’s QBI to the extent that these payments: (i) are related to the patron’s trade or business; (ii) are qualified items of income, gain, deduction, or loss at the cooperative’s trade or business level; and (iii) are not income from a specified service trade or business (SSTB) (as defined in I.R.C. §199A(d)(2)) at the cooperative level. But, they are only included in the patron’s income if the cooperative provides the required information to the patron concerning the payments. Prop. Treas. Reg. §199A-7(c)(2).
* The amount of a patron’s deduction that can be passed through to the patron is limited to the portion of the patron’s deduction that is allowed with respect to qualified production activities income to which the qualified payments (patronage dividends and per unit retains) made to the patron are attributable. I.R.C. §199A(g)(2)(E). In other words, the distribution must be of tax items that are allocable to the cooperative’s trade or business on behalf of or with a patron. The cooperative makes this determination in accordance with Treas. Reg. §1.199A-3(b). This is, essentially, the domestic production activities deduction computation of former I.R.C. §199, except that account is taken for non-patronage income not being part of the computation.
* The farmer-patron must reduce the “patron’s QBID” by a formula that is the lesser of 9 percent of QBI that relates to I.R.C. §199A(b)(7)(A)-(B).
* An optional safe harbor allocation method exists for patrons under the applicable threshold of I.R.C. §199A(e)(2) ($160,700 single/$321,400 MFJ for 2019) to determine the reduction. Under the safe harbor, a patron must allocate the aggregate business expenses and W-2 wages ratably between qualified payments and other gross receipts to determine QBI. Prop. Treas. Reg. §1.199A-7(f)(2)(ii). Thus, the amount of deductions apportioned to determine QBI allocable to qualified payments must be equal to the proportion of the total deductions that the amount of qualified payments bears to total gross receipts used to determine QBI. The same proportion applies to determine the amount of W-2 wages allocable to the portion of the trade or business that received qualified payments.
Note. The proposed regulations attempting to illustrate the calculation only mention gross receipts from grain sales. There is no mention of gross receipts from farm equipment, for example (including I.R.C. §1245 gains from the trade-in of farm equipment). Based on the language of Prop. Treas. Reg. §1.199A-7(f)(2)(ii), gross receipts from the sale of equipment and machinery should be included in the calculation and the farmer would have to allocate gross receipts from equipment sales between patronage and non-patronage income. Indeed, in prior years, depreciation may have been allocated between patronage and non-patronage income. Likewise, the example doesn’t address how government payments received upon sale of grain are to be allocated.
That concludes the top ten list for 2019. Looking back at the Top Ten list, a couple of observations can be made. Clearly, the make-up of the U.S. Supreme Court is highly important to agriculture. Also, the Presidential Administration shapes policy within the regulatory agencies that regulate agricultural and landowner activity, as well as tax policy. Agriculture, on the whole, benefited from favorable U.S. Supreme Court opinions, regulatory developments and tax policy in 2019.
What will 2020 bring?