AgDM newsletter article, December 2002
By George F. Patrick, Department of Agricultural Economics, Purdue University
A number of recent tax law changes are dis-Acussed in the first section of this article. These include a very brief discussion of provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 taking effect in 2002. As a result of the events of September 11, 2001, Congress enacted a provision allowing 30-percent additional first-year depreciation for acquisitions of qualifying property after September 10, 2001. The IRS will automatically consent to a producer’s change in accounting methods with respect to treating Commodity Credit Corporation (CCC) loans as income. Final regulations for farm income averaging were released early in 2002.
Recent Tax Law Changes
The Economic Growth and Tax Relief Reconciliation Act of 2001 had a number of provisions that took effect in 2001 and others take effect in 2002 and later years. The 10 percent tax rate becomes part of the tax schedule for 2002 and tax rates above the 15 percent rate were reduced an additional 0.5 percent for 2002. The earned income credit (EIC) is simplified for 2002 with the definition of a qualifying child being expanded to include descendents of stepchildren and foster children residing with an individual for more than one half of the year. The contribution limit for the Coverdell Educational Savings Accounts (ESA) has been increased to $2,000 annually per beneficiary. Multiple educational incentives for one individual, such as the HOPE Credit, Lifetime Learning Credit and tax-free distributions can now be claimed in the same year for different educational expenses. The five-year limit on the deductibility of interest on student loans is eliminated and the income limitations for deductibility are relaxed. Limitations on contributions to qualified retirement plans generally increase in 2002. For example, limits increase from $2,000 to $3,000 for both regular and Roth individual retirement accounts (IRAs) and individuals age 50 or older are permitted additional contributions.
Additional First-Year Depreciation
The Job Creation and Worker Assistance Act of 2002 allows an additional 30 percent depreciation deduction for qualifying property purchased after September 10, 2001 and before September 11, 2004. The deduction applies to the tax year in which the qualified property is placed in service.
To qualify, the property must be modified accelerated cost recovery system (MACRS) property that has an applicable recovery period of 20 years or less. Thus, in addition to livestock, machinery and equipment, single-purpose livestock/horticultural structures, field tile and general purpose farm buildings (such as machine sheds or hay barns) would qualify.
Original use of the property must commence with the taxpayer after September 10, 2001 and before January 1, 2005. Used machinery and equipment would not qualify. Bred heifers and gilts appear to be eligible for the additional depreciation, but not animals that have previously been used for draft, breeding, dairy or sporting purposes. Listed property, such as vehicles, which are used 50 percent or less for business, do not qualify for the additional depreciation. Producers who must use the Alternative Depreciation System (ADS) on farm assets because they elected out of the capitalization of preproduction period expenses are not eligible for the 30 percent additional first-year depreciation.
The 30 percent additional first-year depreciation is taken after any Section 179 expensing and before regular MACRS depreciation. For example, if a farmer purchases a qualifying $50,000 asset and elects $10,000 Section 179 expensing, then the remaining $40,000 would be eligible for the 30-percent additional first-year depreciation. The $40,000 ´ 30 percent = $12,000 additional first-year depreciation is deducted, leaving $28,000 for regular MACRS depreciation. With no Section 179 expensing, the entire $50,000 would be eligible for the additional first-year depreciation. If the maximum Section 179 expensing of $24,000 for 2002 was applied to this asset, only $26,000 would eligible for the additional 30 percent first-year depreciation.
For acquisitions after December 31, 2001, taxpayers are treated as claiming the 30 percent additional first-year depreciation on all qualifying property unless they elect out of the provision. To elect out of the additional depreciation, a statement indicating the MACRS classes of property for which the individual is electing not to claim the additional 30 percent first-year depreciation is attached to the income tax return. Thus, if a farmer purchased a computer (5-year MACRS property) and a tractor (7-year MACRS property), the farmer could:
|For a further discussion of the income and estate tax changes see Patrick, “Tax Planning and Management Considerations for Farmers in 2001,” Purdue University Cooperative Extension Service, CES Paper No. 338, December 2001, available at www.agecon.purdue.edu/ext/pubs/taxplan2001.pdf|
If the farmer acquired multiple qualifying assets in the same MACRS class in the same tax year, all of those assets would have to be treated in the same way with respect to the 30 percent additional first-year depreciation. If an election was not attached to a timely filed return, an individual can file an amended return within 6 months of the due date of the return (excluding extensions) and make the election out.
Taxpayers filing before June 1, 2002 are treated as having elected out of the 30 percent additional first-year depreciation for acquisitions of qualifying property after September 10, 2001 and before January 1, 2002. However, these taxpayers can file an amended 2001 return by the due date of their 2002 returns (including extensions) and claim the additional depreciation for 2001. Alternatively, a taxpayer can file Form 3115 “Application for a Change in Accounting Method” with their 2002 return and take the additional first-year depreciation for 2001 as a deduction for the 2002 tax year. The taxpayer could also take the second year depreciation on the asset acquired in 2001 as a 2002 deduction.
Revoking Election to Treat CCC Loans as Income
Many producers use the Commodity Credit Corporation (CCC) loan program in which commodities are used for loans at or after harvest. Producers can treat those loans in two ways for tax purposes. Under the loan method, the CCC loans can be treated as other loans –loan proceeds are not treated as income and loan repayment is not a deductible expense. Alternatively, a farmer could elect under Section 77 to treat the loan proceeds as income when received – the income method. Once the election to treat a CCC loan as income was made, it could not be revoked without the IRS Commissioner’s permission. Revenue Procedure 2002-9 adds the Section 77 election to the changes in accounting methods that receive the automatic consent of the Commissioner.
Farmers who have treated CCC loans as income can revoke that election by filing Form 3115 “Application for a Change in Accounting Method.” Because consent is automatic, Form 3115 can be filed with the tax return for the year of the change and there is no user fee charged. The change is made on a cut-off basis. All CCC loans received in the year of change are treated as loans. There is no change with respect to treatment of CCC loans in prior years that have been reported as income. One copy of Form 3115 is filed with the tax return and a copy is sent to the Internal Revenue Service, Associate Chief Counsel (Domestic), Attention CC:DOM CORP:T, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044. Producers have flexibility in reporting future CCC loans. If a producer revokes the Section 77 election for 2002, nothing prevents that producer from electing to report 2003 CCC loans as income. Presumably, the new election could be revoked for the 2004 tax year.
Farm Income Averaging Regulations
Farm income averaging regulations were released in January 2002. In general, these regulations confirm most of the previous interpretations and they do provide some additional guidance. It is clear that farm income averaging does not change income in the election year or in the base years. Farm income averaging borrows the unused tax brackets from the three base years to compute the tax on one-third of the elected farm income for the election year.
The regulations clarify that landowners whose income is based on a share of farm production can treat that income as electible farm income for income averaging. Whether the landowner materially participates in the farm operation is irrelevant for income averaging. However, for 2003 and later years, to consider the farm income as electible farm income, the landowner must have a written agreement with the farm operator before the operator begins significant activities.
The regulations also indicate that farm income averaging does not apply for purposes of calculating the tentative tax for alternative minimum tax (AMT) calculations. The final regulations also allow changes in the farm income averaging election during the three-year time period for filing amended returns.
* For information on specific tax situations, consult a competent tax advisor. For a more basic discussion of income taxes and agriculture see, Patrick and Harris, Income Tax Management for Farmers, NCR#2, MWPS, Iowa State University, 2002.