Tax Cuts and Jobs Act

Article Dean Dorton

By Jen Shah, CPA · Equine Industry Team Leader

Federal tax reform is upon us and, while most provisions in the current bill are effective for calendar years beginning in 2018, there may be some year-end planning items that horse and farm owners should consider prior to December 31, 2017.

As I am writing this article, both the Senate and the House have passed (and re-passed) the current bill and it is widely expected to be signed into law by the President today. While Dean Dorton has previously provided general information regarding what is included in this bill, this article addresses selected items that are specific to horse and farm owners. Unless otherwise noted, the bill is effective for years beginning after December 31, 2017 (so, 2018 for calendar year filers). Most of these provisions apply for a period of time and then revert back to current treatment, but this article focuses on when these items become effective versus the time period for which they are effective.

Depreciation Provisions

Under current law, bonus depreciation (50%) may be claimed on new tangible property purchased and placed in service. The current bill increases the amount eligible to be immediately expensed to 100% of the purchase price and expands the definition of new to include the taxpayer’s first use of the property. So, if I purchase a broodmare, I may now expense 100% of her purchase price, as long as I had not previously owned her. Yearlings, racing prospects, farm equipment and office equipment, land improvements, and barns, to name a few, continue to qualify for this write-off as long as they have not been owned previously by the purchaser. This provision is effective for assets purchased after September 27, 2017.

Increased Section 179 depreciation of $1,000,000 on up to $2,500,000 of qualifying purchases is included with this bill. The bill also expands the definition of qualified property to include HVACs. As a reminder, in order to claim Section 179, there needs to be a net business profit. This is calculated first at the pass-through entity level and then again at the individual level.

Those in the farming business have been required to use 150% declining balance versus the standard 200% declining balance for federal depreciation. This bill removes the requirement to use 150% declining balance so 200% declining balance may be used going forward, which will accelerate depreciation deductions in the first few years. In addition, farm equipment that is currently seven-year life property becomes five-year life property so may be written off over a shorter period of time.

The three-year recovery period for depreciation on yearlings is not included in this bill. So, while the three-year recovery period still applies to racehorses when placed in service after the two-year anniversary of the foaling date, yearlings revert back to a seven-year recovery period. This is effective for years beginning after December 31, 2016, so make sure to update 2017 federal depreciation for this.

Federal Income Tax Rate Provisions

The top income tax rate for individuals will be 37% (versus 39.6% currently). For those who conduct horse operations via partnerships, S corporations, or sole proprietorships, there is a new 20% deduction available against qualified business income but there are many limitations and hurdles to meet in order to qualify for this deduction. This 20% deduction does not reduce an individual’s adjusted gross income but is a reduction from taxable income. Trusts and estates may also qualify for this deduction.

This 20% deduction is limited to the greater of 50% of the allocable portion of wages paid by the business or the sum of 25% of allocable wages plus 2.5% of the allocable unadjusted basis of all qualified property immediately after acquisition. Non-corporate taxpayers with taxable income of less than $157,500 ($315,000 if married filing jointly) are not subject to the W-2 wage limitation when calculating this 20% deduction. For those that exceed this threshold, there may be a potential to qualify for this deduction even if wages are not paid by the entity but depreciable property (like buildings, horses, equipment, et cetera) is held in a trade or business or for the production of income. This portion of the calculation is confusing in the current bill so the above is a bit of an over-simplification.

This 20% deduction generally does not apply to specified service businesses (like accountants or where the principal asset is the reputation or skill of one or more of its employees or owners), but the service business limitation does not apply in the case of a taxpayer whose taxable income does not exceed the applicable thresholds above. As such, bloodstock agents, sales agents, trainers, and vets may fall under the service business limitations.

If you conduct your horse activities via a C corporation, the corporate income tax rate will decrease to 21% and the alternative minimum tax will be eliminated, both of which are good news.

Business Operational Provisions

Business interest expense will continue to be fully deductible for the bulk of industry participants. If average annual gross receipts for the three prior years exceed $25,000,000, then interest expense is limited to 30% of a business’ taxable income, with the excess carrying over to subsequent years. Farming businesses may elect not to be subject to the business interest limitation but would then be required to use Alternative Depreciation System (ADS) (straight-line and longer life) to depreciate property.

Like-kind exchanges of horses, vehicles, and farm equipment are eliminated. Like-kind exchange treatment is only available for real estate going forward, so this will reduce the opportunity for horse and farm owners to defer gain recognition on assets other than real estate for which the proceeds are re-invested in like property.

Meals provided to employees for the convenience of the employer (typically done during peak sale or breeding season hours) are currently 100% deductible but will become 50% deductible. Entertainment expenses will no longer be deductible.

Net Federal Income Tax Losses Generated by Active Businesses

Lastly, this next provision affects active business owners so will affect more than just the equine industry but may have a detrimental effect for those horse and farm owners that generate business losses which are offset by non-business income such as investment income. Under current law, excess farming losses are only limited if the farm receives a subsidy, which does not apply to many horse farm owners. Under this bill, a new section limits any excess business loss generated by an individual to ($250,000) (or ($500,000) if married filing jointly). This threshold applies after the active participation rules are applied and includes any trade or business, not just farming.

Business activities may be netted on an individual’s income tax return to determine if the loss threshold has been exceeded. Any excess business loss beyond the above threshold becomes a net operating loss that rolls forward into the subsequent year. Given the accelerated deductions available to horse owners in years prior to the potential to generate income, quite often net taxable losses will be reported, especially in start-up years. This provision has the effect of at least a one-year deferral for these excess business losses and may negatively impact those who fund business operations with assets that generate investment income.

So, while this bill is primarily effective post-2017, what are some items that should be considered prior to December 31, 2017?

  • Consider accelerating expenses into 2017 for active businesses owned by individuals. There should be a non-tax reason for doing so (for example, discount available, accessibility to certain stallions solely as a result of prepayment, et cetera).
  • Calculate the 2017 versus 2018 income tax impact of accelerating income for individuals into 2017 and paying the related state and local taxes (since the deduction for state and local taxes is limited to $10,000 after 2017) by year-end.
  • Determine if 2017 state, local, real estate, and/or sales tax should be paid by individuals not in Alternative Minimum Tax (AMT) prior to December 31, 2017. Note that there is no deduction allowed in 2017 for the prepayment of 2018 taxes.
  • If the horse or farm owner makes contributions to charity in exchange for preferred seating at athletic events (like the University of Kentucky’s K Fund), consider paying now. Currently, a charitable deduction for 80% of the amount contributed is allowed but this will be eliminated in future years.

This proposed bill certainly does not accomplish income tax simplification (and some have indicated that this will keep us tax accountants in business for quite some time) and creates many gray areas subject to interpretation without the existence of additional regulations. We are doing our best to interpret this bill as we understand it but know that we plan to send updates as additional clarifications are released in 2018.

Should you have any questions regarding federal tax reform and its potential impact on your 2017 or 2018 equine operations, please do not hesitate to contact us.

Jen Shah, CPA
Director of Tax Services
Equine Industry Team Leader

View Jen’s Bio

Article Dean Dorton

On Friday evening, congressional Republicans released the final version of their tax overhaul plan. The plan will be voted on this week with the goal of President Trump signing the bill into law before Christmas. The Republicans believe they have enough votes to pass this plan and are anticipating no Democratic support.

The new bill looks a lot like earlier versions from the House and Senate with some modifications. One of the initial goals of the tax legislation was simplification of the tax code. This bill does not represent significant tax simplification, but does represent the most sweeping change to the Tax Code since 1986. This final bill carries a January 1, 2018 effective date for most provisions. Given the size and complexity of the tax bill, this summary only highlights a few selected items.Individual Tax Rates
Old Law:
Under current tax law, the individual income tax brackets are structured as follows:

Tax Rate Single Married Filing Joint (MFJ)
10% $0 – $9,325 $0 – $18,650
15% $9,326 – $37,950 $18,651 – $75,900
25% $37,951 – $91,900 $75,901 – $153,100
28% $91,901 – $191,650 $153,101 – $233,350
33% $191,651 – $416,700 $233,351 – $416,700
35% $416,701 – $418,400 $416,701 – $470,700
39.6% $418,401+ $470,701+

New Law:
Under the proposed tax law, the individual income tax brackets are structured as follows:

Tax Rate Single Married Filing Joint (MFJ)
10% $0 – $9,525 $0 – $19,050
12% $9,526 – $38,700 $19,051 – $77,400
22% $38,701 – $82,500 $77,401 – $165,000
24% $82,501 – $157,500 $165,001 – $315,000
32% $157,501 – $200,000 $315,001 – $400,000
35% $200,001 – $500,000 $400,001 – $600,000
37% $500,001+ $600,001+

Personal Exemptions and Standard DeductionOld Law:
Personal exemptions generally are allowed for the taxpayer, the taxpayer’s spouse, and any dependents. The amount deductible for each personal exemption is $4,050 for 2017, subject to a phase-out for higher earners. Taxpayers are allowed a standard deduction of $6,350 single/$12,700 MFJ.

New Law:
The personal exemptions are eliminated and the standard deductions increased to $12,000 single/$24,000 MFJ, indexed for inflation for tax years beginning after 2018.State, Local and Property TaxesOld Law:
Taxes paid at the state and local level, including real and personal property taxes, income taxes, and/or sales taxes can be deducted from a taxpayer’s taxable income as an itemized deduction. 

New Law:
For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the combined deduction for property taxes and state and local income taxes, is limited to $10,000 MFJ. Sales taxes may be included as an alternative to claiming state and local income taxes.Mortgage InterestOld Law:
Taxpayers who itemize their deductions may deduct interest payments on the first $1 million in acquisition indebtedness (for acquiring, constructing, or substantially improving a residence), and up to $100,000 in home equity indebtedness.

New Law:
For home acquisition indebtedness incurred before December 15, 2017, the limitation remains at $1 million. Home acquisition debt incurred after this date is subject to a $750,000 limitation. The law eliminates the deduction for home equity indebtedness.Medical ExpensesOld Law:
Under current tax law, the threshold for deduction is 10% of AGI.

New Law:
For tax years beginning after Dec. 31, 2016 and ending before Jan. 1, 2019, the threshold for deduction is reduced to 7.5% of AGI. However, this adjustment is only temporary, as the threshold for deduction will return to 10% of AGI for tax years beginning after Dec. 31, 2018.Charitable Contributions for Purchase of Seating to College and University Athletic EventsOld Law:
A taxpayer that purchases tickets for seating at an athletic event for an educational organization, may take a charitable deduction for 80% of the amount contributed (example – UK Blue/White Fund).

New Law:
For tax years beginning after Dec. 31, 2017, taxpayers will no longer be able to take a charitable deduction for any portion of contribution made to an athletic event for an educational organization.Expanded Use of Sec. 529 Account FundsOld Law:
Funds in a Sec. 529 college savings account could only be used for qualified higher education expenses. “Qualified higher education expenses” included tuition, fees, books, supplies, and required equipment, as well as reasonable room and board if the student was enrolled at least half-time.

New Law:
For distributions after Dec. 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home school, up to a $10,000 limit per tax year.Individual – Alternative Minimum Tax (AMT)Old Law:
Under current tax law, the AMT exemption amounts are $53,900 for individual filers and $83,800 MFJ. The exemption phase-out amounts are $335,300 for individual filers and $494,900 MFJ.

New Law:
For tax years beginning after Dec. 31, 2017 and ending before Jan. 1, 2026, the AMT exemption amounts will be $70,300 for single filers and $109,400 MFJ. Additionally, the exemption phase-out amounts will be $500,000 for single filers and $1,000,000 MFJ.Estate & Gift TaxOld Law:
The first $5 million, basic exclusion adjusted for inflation after 2011, was exempt from estate and gift tax.

New Law:
The estate and gift tax basic exclusion amount is doubled from $5,000,000 to $10,000,000, indexed for inflation. The generation skipping transfer (GST) exemption amount is also increased to $10,000,000, indexed for inflation. These changes are effective for decedents dying and for gifts made after Dec. 31, 2017 and before Jan. 1, 2026. The bill does not provide for a repeal of the estate or GST tax in the future.Corporate Tax Rates

Income Tax Rate Taxable Income Levels:
Old Law New Law*
15% 21% $0 – $50,000
25% 21% $50,000-$75,000
34% 21% $75,000 – $100,000
39% 21% $100,000-$335,000
34% 21% $335,000 – $10,000,000
35% 21% $10,000,000-$15,000,000
38% 21% $15,000,000 – 18,333,333
35% 21% $18,333,000+

* Personal Service Corporations (PSC) receive no special tax rate.Pass-Through EntitiesOld Law:
The net income of sole proprietorships, partnerships, limited liability companies, and S corporations was not subject to an entity-level tax, and was instead included in taxable income on an owner’s or shareholder’s individual income tax return. This rate could have been as high as 39.6%.

New Law:
Generally, for tax years beginning after December 31, 2017 and before January 1, 2026, individual taxpayers with domestic “qualified business income” from sole proprietorships, partnerships and S corporations would be allowed a new deduction of up to 20% this income. Qualified business income is defined as other than investment income (e.g., dividends, interest income, capital gains, etc.). The deduction could not exceed the greater of:

  1. 50% of the taxpayer’s allocable portion of W-2 wages paid, or
  2. The sum of 25% of the taxpayer’s allocated W-2 wages plus 2.5% of the taxpayer’s allocated unadjusted basis, immediately after acquisition of all “qualified property”. Qualified property is defined as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

This second limitation would allow businesses to be eligible for the deduction based on owning property that qualified under the provision, with or without applicable wages.

However, the W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $315,000 for MFJ ($157,500 for other individuals). The application of the W-2 wage limit is phased in for individuals with taxable income exceeding these thresholds over the next $100,000 of taxable income for MFJ ($50,000 for other individuals).

The deduction generally does not apply to specified service businesses, but the service business limitation does not apply in the case of a taxpayer whose taxable income does not exceed the applicable thresholds above.Corporate – Alternative Minimum TaxOld Law:
The corporate AMT is 20%, with an exemption amount of up to $40,000. Corporations with average gross receipts of less than $7.5 million for the preceding three tax years are exempt from the AMT. The exemption amount phases out starting at $150,000 of alternative minimum taxable income.

New Law:
The corporate AMT is repealed for tax years beginning after 2017. In addition, for years beginning after 2017 and before 2022, the AMT credit is refundable and can offset regular tax liability in an amount equal to 50% (100% for tax years beginning in 2021) of the excess of the minimum tax credit for the tax year over the amount of the credit allowable for the year against regular tax liability. Accordingly, the full amount of the minimum tax credit will be allowed in tax years beginning before 2022.Depreciation

Old Law:
Bonus Depreciation – 50% for qualified property placed in service during the tax year. Beginning with property placed in service after Dec. 31, 2017 and before Jan. 1, 2020, the bonus depreciation rate is reduced to 40%, with the deduction expiring after 2019. Additionally, the definition of qualified property includes the requirement that the original use of property commence with the taxpayer. As such, used property is not eligible for bonus deprecation.

Sec. 179 Deduction – The maximum amount that may be expensed under this provision is $510,000. Additionally, the phase-out threshold for the deduction is $2,030,000. These amounts are permanently extended and indexed for inflation.

Farm Property – Machinery and equipment used in farming operations have a useful life of 7 years, and must be depreciated using the 150% declining balance method.

New Law:
Bonus Depreciation – 100% (full expensing) for qualified property acquired and placed in service after September 27, 2017 and before Jan. 1, 2023. Beginning with 2023, bonus depreciation will be phased out at a rate of 20% each year until fully phased out after 2027. Additionally, the requirement that the original use of property commence with the taxpayer has been removed. As such, the definition of qualified property is effectively expanded to include used property.

Sec. 179 Deduction – The maximum amount that may be expensed under this provision is $1,000,000. Additionally, the phase-out threshold for the deduction is $2,500,000. Beginning with property acquired after Dec. 31, 2018, both the maximum deduction and phase-out amount will be indexed for inflation.

Farm Property – Machinery and equipment used in farming operations have a useful life of 5 years, and are now depreciated using the 200% declining balance method.Business Interest Deduction LimitationsOld Law:
Business interest paid or accrued is generally deductible.

New Law:
For tax years beginning after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s “adjusted taxable income”. The net interest expense disallowance is determined at the taxpayer level. However, a special rule applies to pass-through entities such as S Corporations or Partnerships, which require the determination to be made at the entity level.

For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2022, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion and without the former domestic production deduction (which is repealed effective Dec. 31, 2017).  An exemption rule applies for taxpayers with average annual gross receipts of less than $25 million for the prior three-year period.DisclaimerThe information presented is not intended to be a full and exhaustive explanation of the tax bills referenced as there are many more provisions. Please consult with your tax advisor regarding the policies that might be applicable to your specific situation.