Not much has changed from an income tax perspective since I wrote the below article. Most elections have occurred and we still have some uncertainty on a few races. But there have been no stimulus relief bills or tax law updates yet, so as year-end approaches, keep these planning ideas in mind for 2020.
This article was first published in the November 6th edition of the Blood Horse Magazine
Written by: Jen Shah, CPA
As I write this article, the elections have not yet occurred. Much of my recent conversations with our clients, many of whom are horse and farm owners with other operating businesses and/or significant investment portfolios, have focused on “what ifs” – e.g., what happens to income tax rates or the lifetime gifting exemption if there is a change of political party control in Congress and/or the White House. Perhaps by the time you are reading this article, we will know who our next President is and which political party controls each chamber of Congress. In the meantime, this article includes a few tax planning items that may be helpful as year-end approaches. The items discussed below are current as of October 29th, 2020.
Let’s first focus on some year-end income tax planning items. 2020 could be the optimal year to accelerate deductions in your horse operations (or other operating businesses) both for individuals and C corporations. The CARES Act, passed in March 2020, included two particularly beneficial provisions for industry participants:
- Allowing net operating losses generated in 2020 (and also 2018 and 2019) to be carried back five years (applies to both individuals and C corporations), and
- Temporarily postponing the new excess business loss (EBL) limitation until 2021 (applies to individuals). These provisions were discussed in our article which appeared in the May 2nd issue of the BloodHorse, so I have not included detailed information about them here.
If the goal is to accelerate deductions this year, then consider purchasing and placing in service (meaning the asset is ready to be used for its intended purpose) assets which qualify for the 100% bonus depreciation by 12/31/20. Qualifying assets, which must be used predominantly in the United States, include equipment, fencing, land improvements, barns, and most horse purchases (with some exceptions). In addition to the above favorable depreciation write-off, many horse and farm owners qualify to use the cash method of accounting when filing annual tax returns. If you are cash-basis, consider pre-paying expenses by year-end. Please note, however, that you should have a non-tax reason for doing so. Non-tax reasons may include bulk or early payment discounts obtained for expenditures such as feed, supplies, or advertising or for access to a particular stallion.
The above commentary assumes your horse operations are conducted as a business and you are either an active participant under the material participation rules (a description of which is beyond the scope of this article) or have enough other passive activity income to offset these losses.
For individuals who are charitably-inclined, cash contributions made to qualified public operating charities (NOT including donor-advised funds, however) by year-end may offset up to 100% of your adjusted gross income for 2020 only. For C corporations, these contributions may offset up to 25% of 2020 taxable income (up from the normal 10%).
In addition to year-end income tax considerations, it may be prudent to address estate planning matters. One of the most effective ways to do this is via lifetime gifts. First, a few basics regarding gifting – Annual gifts of $15,000 may be given to US citizens free of gift and generation skipping tax (GST). In addition to this annual gift limit, the 2020 lifetime gift and GST exclusion is $11.58 million per person. If the lifetime threshold is exceeded, then the gift is taxable to the person who makes the gift at a 40% gift tax rate and a 40% GST rate (if applicable). The GST is charged in addition to the gift tax if gifts are made to a person who is more than 37.5 years younger than the person making the gift, the intent being to capture the additional tax on gifts that may skip a generation (the most common of which may be gifts to grandchildren).
The lifetime gift and GST exemption significantly increased in 2018 as part of the Tax Cuts and Jobs Act (TCJA) and is scheduled to be at an increased level through 2025 (amount adjusted annually for inflation). In 2026, this lifetime exemption is scheduled to revert to the 2017 limitation of $5 million (plus subsequent inflation adjustments). If the Democrats take control of the White House and/or Congress, many expect a push to pass legislation that reduces these increased annual gifting and GST exemptions sooner than the scheduled 2026 reduction.
An ideal asset to gift is property that is expected to appreciate in value. If you gift something worth $100,000 today and it appreciates to $500,000 at your death, then you’ve gotten $500,000 out of your estate and only used $100,000 of lifetime gifting exemption. On the other hand, if that $100,000 gift depreciates to a $40,000 value, then you’ve potentially wasted $60,000 of lifetime gifting exemption.
Equine assets may also be included in your gifting plan, albeit some equine assets may be more effective than others. Horses are tricky with regard to gifting as it certainly can be difficult to determine whether or not they will appreciate in value. If you want horses to be part of your gifting plan, consider stallion shares from an already profitable stallion (which produces cash-flow) or a broodmare interest versus younger racing prospects. Of course, the person receiving this gift will then be responsible for care of the horses, so that ongoing expense should be considered. Farms, on the other hand, tend to be held long-term which hopefully will lead to appreciation over time.
To maximize the gift, assets are often contributed to a pass-through entity (holding company) by parents or grandparents. Non-controlling interests in this holding company are either gifted or sold at a discount to the children or grandchildren (or trusts for their benefit) with the voting interest retained by the original owner.
Those who made large gifts prior to 2018 may still have substantial exemptions remaining due to the significant increase in the exemption. I recommend discussing this now with your advisors if you are interested in considering gifts by year-end and gaining the benefit of the current historically high exemptions.
As the saying goes, nothing is certain in life except death and taxes. The first is unavoidable, but exposure to the second may be managed via effective tax planning, some of which is mentioned above. It will be interesting to see what impact, if any, the results of the election have on tax planning.