Farmers can lower their taxable income and plan for the future of their operations by taking advantage of several provisions included in the recently approved American Taxpayer Relief Act of 2012. Let's take a look at just how farmers will be affected by these changes to capital gains, Section 179, bonus depreciation, the federal estate tax and the alternative minimum tax (AMT).
Tina LeBrun & Wayne Schoper
Capital gains tax rates have become more complicated to calculate, but it looks like most farm assets sold will be subject to approximately 15 percent capital gains tax. Capital gains rates most often affect farmers who purchase farmland and later sell it at a higher price. The difference between the purchase price and the sale price is taxed at the relevant capital gains rate.
Under the new law, factors affecting the capital gains rate include income bracket, itemized deductions, gross income and personal exemptions. For example, a farmer who itemizes deductions and has a gross income above a certain level will experience phaseouts of itemized deductions and personal exemptions.
In general, most farmers making less than $250,000 per year will pay a capital gains rate of 15 percent starting with the 2013 tax year. The 0 percent rate will still apply for lower -income taxpayers. Those making above that amount generally will pay a tax rate between 20 percent and 25 percent, based on taxable income.
High-level Section 179 deduction extended:
Farmers who have benefited from the Section 179 deduction for farm equipment and some land improvements will continue to enjoy a high deduction amount of $500,000 for the 2012 and 2013 tax years. For the last several years, the deduction has fluctuated between $125,000 and $500,000 in an effort to encourage machinery buying and stimulate the economy. The deduction will drop back to $25,000 in 2014.
Farmers would normally depreciate a piece of machinery over a period of seven years. But the extension allows an operator to deduct up to $500,000 of equipment placed into service during the fiscal year for which he or she is filing taxes. Section 179 expensing of capital assets can be used on any asset (new or used) other than general purpose buildings like machine sheds and shops, as long as it is not purchased from a relative. This does include single purpose buildings as well as tile and land improvements.
extended at 50 percent:
Farmers who put new assets such as equipment and machine sheds into use between Jan. 1, 2012 and Dec. 31, 2013 can take advantage of a 50 percent deduction known as bonus depreciation. There is no investment limit or taxable income limit for that deduction.
A farmer who builds a shop for $250,000, for example, can immediately deduct $125,000. The only stipulation is that the assets in question must be new, not used and the balance of the cost must be depreciated over 20 years.
Federal estate tax rate becomes permanent:
The federal estate tax is applied upon a farmer's death. Whether a farmer's survivors must pay the tax is determined by taking the total fair market value of his or her assets and subtracting any liabilities. If the resulting net worth is less than the lifetime exclusion, no taxes are owed. If the resulting net worth is greater than the exclusion, taxes are due.
For 2012, the lifetime exclusion is $5.12 million, and that figure will rise to $5.25 million for 2013. Under the new law, the estate tax rate rises from 35 percent in 2012 to a permanent 40 percent in 2013. Portability for spouses also has been made permanent.
That means a farmer who doesn't make any taxable gifts during his lifetime and dies with a net worth of less than $5.25 million will not owe any estate tax. By contrast, a farmer with a net worth of $10 million will owe taxes at a rate of 40 percent on assets above the $5.25 million exclusion.
While the $5 million annual exclusion will only remain in effect until Congress decides to change it, the permanence provides added security to farm families.
Alternative minimum tax changes help
Middle-income farmers stand to benefit from changes to the alternative minimum tax (AMT). Congress decided to index that tax to inflation permanently, meaning affected farmers will avoid seeing a possible annual tax increase of between $2,000 and $12,000.
The tax introduced in 1986 wasn't originally indexed to inflation, meaning Congress had to pass a patch every one to two years to increase the exemption amount. The tax affects about 5 million people. Without a patch, the tax would have affected about 30 million people making between $50,000 and $200,000. That doesn't mean all middle-income farmers are exempt from AMT. It simply means the rate will remain lower than it might have been.