The world of ag law never stops. Here are some of the recent changes in the law that impact agriculture. Every once in a while, a quick tour is in order.
Within that, the constant is that taxes will change but will always be present.
The likelihood that major tax reform legislation will be introduced and passed in 2017 is high. Some believe that like-kind exchanges remain at a high risk for repeal. Many have used this process to delay capital gains tax by selling farm ground, and instead of taking a check, replacing it with additional farm ground in other areas. As equipment becomes bigger, the value of having adjoining parcels cannot be disputed.
In the local market, pressure in the mid 2000’s came from investors with proceeds from sales near large metropolitan areas. These investors were quick to bid up ground, as they were motivated to delay paying capital gains. As the market tapered off slightly, the investors sold their holdings locally and moved towards Missouri and Kansas where ground was not booming at the same rate.
Land can account for up to 100% of farm operators “retirement”, and is on average, 30% of commercial investments. The statewide average value for an acre of farmland is about 17.5% lower than 2013 peak values, with declining values for the last three years (5.9% in 2016). Prices stay high when demand is high and supply is low. The desire to avoid capital gains tax has been shown to increase demand. The lion’s share of ground in Iowa is held by those who have a high probability of needing expensive nursing home care in the next 20 years. Like-kind exchanges could help keep the market up for land prices, even in the face of additional sales in the coming years.
The House Republican Blueprint for Tax Reform doesn’t address like-kind exchanges, which are disfavored by some. It proposes full expensing for all capital asset acquisitions, excluding the cost of the land. Right now, land improvements of certain types need to be added to the basis of the property, and not deducted as an expense or depreciated. Full depreciation of real property improvements may well face stiff resistance.
The Blueprint proposes a maximum tax rate of 16.5% for capital gains. President Trump has proposed a maximum rate of 20%.
Leases are old news in the U.S. farm community; we have been doing them for a long time. However, how we lease is changing. Landowners are recognizing the value of the data generated by the farm operator in order to make better decisions about what the land value might truly be. Tenants are using the data to determine which farms are truly profitable, and which ones are lemons to be shed or demanded lower rent for.
You can choose from several types of lease arrangements. They all come down to three basic types:
Crop share production, government payments, and crop insurance are shared between the landowner, and the operator who provides the labor. These arrangements also involve sharing crop expenses. The problem is the landowner is still worrying about the weather and the markets. It is a great fit for the first couple of years after a land owner has had to quit farming themselves. It is almost like a half-way house for farm land owners moving to cash rent arrangements.
Cash rent really needs little explanation. The key is setting the price and the timing of when the payments are due.
Flexible lease arrangements provide a base cash rent, plus a bonus, which represents a share of gross revenue in excess of a base value. This allows the landowner to have a set price, but still capture some of the good year’s prices. It also ensures that in bad years, tenants aren’t paying for a tuxedo when all they needed was flip flops and a bathing suit.
If you have ever bought a pie, you know buying the whole pie is the only way to decide if it makes it Thanksgiving dinner or if you eat it alone in the dark. Consider this, you buy a pie for $10.00. Then If someone gave you 1/4th of a second, exactly the same pie but told you that the pie can’t be eaten until the other owner says so and they get to store the pie, that second pie’s ¼ interest should be worth less than the $2.50 that simple math would suggest. Not if you work for the government.
The IRS released proposed regulations in August that would enhance code sections regarding valuation of privately-held, minority interests that are controlled by the same family. This means LLCs, corporations and partnerships that many farm and small business operators use. It wasn’t out of the blue that the IRS decided to adjust the code, they lost in court and see a potential loss in revenue, so they are changing the rules.
This will impact intra-family interest transfers like when an elder generation gifts a portion of the farm via LLC membership interest to the next generation. The prevailing theory is giving Junior 1/8 of the farm isn’t really worth 1/8 of the total value of the operation because Junior probably still takes orders from Ma and Pa and can’t control the company in any meaningful way and the company is not something that Junior could turn around and sell for 1/8th of the total value to a disinterested party. Think about that pie again.
Valuation principles have long been established showing that Junior interests in privately-held businesses like that are worth less than controlling (Ma and Pa) interests or similar interests in publicly-held companies like Target, IBM and the like . It makes sense that certain adjustments are made when valuing Junior interests in family contexts.
The two most common adjustments are discount for lack of control and the discount for lack of marketability. A discount for lack of control discounts the value of a business interest because Junior does not have the ability to manage the operations of the business and also does not have the ability to control the business. The discount for lack of marketability discounts value of a business interest because the interest cannot be sold and converted to cash as quickly as a publicly traded stock. Many take a 10-20% discount for these impairments.
The IRS has had some leeway in calling out sham discounts however, the latest set of amendments look pretty grim.
They include special valuation rules for such as:
Disregarding Restrictions – No discount for a buy sell restriction on who you can sell your interest to.
•Elimination of Assignee Interest – No discount for the situations where the stock doesn’t have full rights, like when a spouse ends up with the family stock but doesn’t get voting rights.
Three Year Lookback – Makes transfers made within three years of death not eligible for a discount.
Assumed Put Option –Assumes that the junior holder in a family-owned business can sell back at full price within six months. Family owned business do not grant put provisions as they cause liquidity problems which would cripple the operations of the company, when owners can withdraw and demand cash at any time.
Family-owned businesses will lose lose an estate planning tool for families that a valid business purpose for junior interest, like running a farm and separating off farm heirs from on farm decisions.
This is a big change from the ways accepted by the IRS and tax court in years past. It invites a court challenge, which could create uncertainty for an extended period of time.
The regulations are subject to a 90-day public comment through November 2, 2016. Those interested in posting public comments should look at at: https://www.federalregister.gov/articles/2016/08/04/2016-18370/estate-gift-and-generation-skipping-transfer-taxes-restrictions-on-liquidation-of-an-interest
If placed into effect gifts made before the actual implementation will not be subject to the new restrictions (unles the IRS forgets about the Consitutional provision on ex post facto laws). If entities are formed now but gifted after the change they will be subject to the new view. The new rules could be in effect before the end of the year, as early as Dec 2016.
With harvest inbound, your operation may be considering bringing on a person to help run the grain cart, help unload or do relief milking while you handle the harvest. Here is a refresher of the rules you need to be aware of.
Employee versus independent contractor is a something that has been covered here previously, but bottom line is that if you tell the person how what when where and in what order, they are an employee. If you simply tell them what the goal is (i.e. need the field combined and the grain in the grain bin) and they provide some or all of their own equipment, with no rules from you about the order, timing (other than a dead line) and who does the work, they may be an independent contractor and not subject to Employer employee rules.
Next do you have an ag employee?
The IRS defines an agricultural employer as an entity who:
Raises or harvests agricultural or horticultural products (including the raising and feeding of livestock);
Works in connection with the operation, management, conservation, improvement, or maintenance of the farm and its tools and equipment;
Handles, processes, or packages any agricultural or horticultural commodity they produce
The term “farm” includes stock, dairy, poultry, fruit, fur-bearing animals, and truck farms, as well as plantations, ranches, nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards.
Farm work doesn’t include reselling activities that don’t involve any substantial activity of raising agricultural or horticultural commodities, such as a retail store or greenhouse used primarily for display or storage.
Workers’ Compensation Exemption under Iowa worker’s compensation law
Iowa farmers do not have to provide workers’ compensation for employees unless the payroll amounts to $2,500 in the calendar year. When you have to buy it, all employees will be covered. There are large fines and possible felony charges for not carrying workers’ compensation. Federal law requires a farmer employing H-2A workers provide workers’ compensation to all employees. Workman’s compensation coverage does provide a benefit to you as it is the employee’s only recourse if they are injured and covered. Sometimes money spent upfront prevents greater problems later.
There are some exemptions to the statute for ag-related persons:
The employer’s spouse, parents, siblings, stepchildren (including the spouse’s stepchildren), and the siblings, children and stepchildren of the employer’s spouse whether they are in a partnership or corporation or LLC engaged in farming.
Federal and State Unemployment Taxes
Federal Unemployment Tax is not required for employer’s parent or spouse or by employer’s child under age 21.
State reporting and unemployment insurance taxes must be paid by agricultural employers that paid cash wages of $20,000 or more to agricultural laborers, or employed 10 or more workers in some portion of a day in 20 separate weeks in the current calendar year or preceding calendar year.
Fair Labor Standards Act (FLSA) and Agricultural Employers-Overtime
Employees who are employed in agriculture are exempt from the overtime pay provisions. Agriculture does not include work performed on a farm which is not incidental to or in conjunction with such farmer’s farming operation. Think of the hired man dry walling the basement in the wintertime for the kid’s room.
Any employer in agriculture who did not utilize more than 500 “man days” of agricultural labor in any quarter year is exempt from the minimum wage and overtime pay provisions of FLSA for the current calendar year. A “man day” is defined as any day during which an employee performs agricultural work for at least one hour. Additional exemptions from the minimum wage and overtime provisions of FLSA for agricultural employees apply to the following:
Agricultural employees who are immediate family members of their employer
Those principally engaged on the range in the production of livestock
Employment of your children
If under the age of 18, a parent is not required to withhold social security tax and wages not subject to federal unemployment taxes until reaching the age of 21. As long as the total income doesn’t exceed $6,200 and unearned income doesn’t exceed $350, the child will not owe income tax on their income. You still need to send W-2 and pay a wage that is comparable to work done.
IRS Additional Information
Income tax withholding, Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000) are exempt for employer’s child under age 18, but counted for $150 test or $2,500 test. Taxable for spouse of employer.
$150 or $2,500 Test
All cash wages paid to an employee during the year for are subject to social security and Medicare taxes and federal income tax withholding if either of the below is met:
You pay cash wages to an employee of $150 or more in a year for farm work. The $150 test applies separately to each farmworker that you employ.
The total you pay for to all your employees is $2,500 or more during the year.
Compensation paid to H-2A workers for agricultural labor performed in connection with the visa isn’t subject to social security and Medicare taxes and an employer is not required to withhold federal income tax.