[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
AGRICULTURE AND TAX REFORM: OPPORTUNITIES FOR RURAL AMERICA
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
APRIL 5, 2017
__________
Serial No. 115-5
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT
Printed for the use of the Committee on Agriculture
agriculture.house.gov
__________
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25-085 PDF WASHINGTON : 2017
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COMMITTEE ON AGRICULTURE
K. MICHAEL CONAWAY, Texas, Chairman
GLENN THOMPSON, Pennsylvania COLLIN C. PETERSON, Minnesota,
Vice Chairman Ranking Minority Member
BOB GOODLATTE, Virginia, FILEMON VELA, Texas, Vice Ranking
FRANK D. LUCAS, Oklahoma Minority Member
STEVE KING, Iowa DAVID SCOTT, Georgia
MIKE ROGERS, Alabama JIM COSTA, California
BOB GIBBS, Ohio TIMOTHY J. WALZ, Minnesota
AUSTIN SCOTT, Georgia MARCIA L. FUDGE, Ohio
ERIC A. ``RICK'' CRAWFORD, Arkansas JAMES P. McGOVERN, Massachusetts
SCOTT DesJARLAIS, Tennessee MICHELLE LUJAN GRISHAM, New Mexico
VICKY HARTZLER, Missouri ANN M. KUSTER, New Hampshire
JEFF DENHAM, California RICHARD M. NOLAN, Minnesota
DOUG LaMALFA, California CHERI BUSTOS, Illinois
RODNEY DAVIS, Illinois SEAN PATRICK MALONEY, New York
TED S. YOHO, Florida STACEY E. PLASKETT, Virgin Islands
RICK W. ALLEN, Georgia ALMA S. ADAMS, North Carolina
MIKE BOST, Illinois DWIGHT EVANS, Pennsylvania
DAVID ROUZER, North Carolina AL LAWSON, Jr., Florida
RALPH LEE ABRAHAM, Louisiana TOM O'HALLERAN, Arizona
TRENT KELLY, Mississippi JIMMY PANETTA, California
JAMES COMER, Kentucky DARREN SOTO, Florida
ROGER W. MARSHALL, Kansas LISA BLUNT ROCHESTER, Delaware
DON BACON, Nebraska
JOHN J. FASO, New York
NEAL P. DUNN, Florida
JODEY C. ARRINGTON, Texas
______
Matthew S. Schertz, Staff Director
Anne Simmons, Minority Staff Director
(ii)
C O N T E N T S
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Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, opening statement....................................... 1
Prepared statement........................................... 2
Peterson, Hon. Collin C., a Representative in Congress from
Minnesota, opening statement................................... 3
Submitted article............................................ 65
Witnesses
Noem, Hon. Kristi L., a Representative in Congress from South
Dakota......................................................... 4
Jenkins, Hon. Lynn, a Representative in Congress from Kansas..... 6
Wolff, Patricia A., Senior Director, Congressional Relations,
American Farm Bureau Federation, Washington, D.C............... 7
Prepared statement........................................... 9
Claussen, CPA, Doug, Principal, KCoe Isom LLP, Cambridge,
NE............................................................. 12
Prepared statement........................................... 13
Hesse, CPA, Christopher W., Principal, CliftonLarsonAllen, LLP,
Minneapolis, MN................................................ 16
Prepared statement........................................... 18
van der Hoeven, Guido, Extension Specialist/Senior Lecturer,
Department of Agricultural and Resource Economics, North
Carolina State University, Raleigh, NC......................... 23
Prepared statement........................................... 24
Williamson, Ph.D., James M., Economist, Economic Research
Service, U.S. Department of Agriculture, Washington, D.C....... 28
Prepared statement........................................... 29
Submitted questions.......................................... 92
Submitted Material
Brown, William E., President, National Association of
REALTORS', submitted letter......................... 76
Chacon, Stephen, President, Federation of Exchange Accommodators,
et al., submitted letter....................................... 77
Johnson, Roger, President, National Farmers Union, submitted
letter......................................................... 82
Harl, Ph.D., Neil E., Charles F. Curtiss Distinguished Professor
and Professor Emeritus of Economics, Department of Economics,
Iowa State University, submitted statement..................... 85
Tenny, Dave, President and Chief Executive Officer, National
Alliance of Forest Owners, submitted statement................. 89
American Farm Bureau Federation, submitted joint letter.......... 89
American Forest Foundation, submitted statement.................. 90
Like-Kind Exchange Stakeholder Coalition, submitted letter....... 83
National Council of Farmer Cooperatives, submitted statement..... 91
AGRICULTURE AND TAX REFORM: OPPORTUNITIES FOR RURAL AMERICA
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WEDNESDAY, APRIL 5, 2017
House of Representatives,
Committee on Agriculture,
Washington, D.C.
The Committee met, pursuant to call, at 10:00 a.m., in Room
1300 of the Longworth House Office Building, Hon. K. Michael
Conaway [Chairman of the Committee] presiding.
Members present: Representatives Conaway, Lucas, King,
Gibbs, Crawford, Davis, Yoho, Allen, Bost, Rouzer, Kelly,
Comer, Marshall, Bacon, Faso, Dunn, Arrington, Peterson, Walz,
Fudge, McGovern, Vela, Lujan Grisham, Kuster, Nolan, Bustos,
Plaskett, Evans, O'Halleran, Panetta, Soto, and Blunt
Rochester.
Staff present: Bart Fischer, Callie McAdams, Darryl Blakey,
Haley Graves, Matthew S. Schertz, Paul Balzano, Stephanie
Addison, Anne Simmons, Liz Friedlander, Matthew MacKenzie, Mike
Stranz, Troy Phillips, Nicole Scott, and Carly Reedholm.
OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE
IN CONGRESS FROM TEXAS
The Chairman. Good morning. I call this hearing to order.
And I would ask Rick Crawford to offer a quick prayer for us.
Rick.
Mr. Crawford. Thank you, Mr. Chairman.
Heavenly Father, we do bow humbly before you today,
thankful for every blessing of life. Lord, thankful for this
nation that you provided us with. Father, I would just ask that
you be with each one here today, that you would give us
discernment and forbearance, and a temper that reflects your
grace, Father. We ask it all in Jesus' name. Amen.
The Chairman. Thank you, Rick.
The hearing of the Committee on Agriculture entitled,
Agriculture and Tax Reform: Opportunities for Rural America,
will come to order.
Good morning. I would like to welcome all of you today to
today's hearing about examining how the Tax Code impacts on
American agricultural producers. Much like it did in 1985 and
1986, tax reform is poised to again consume much of
Washington's attention. Before that happens, today's hearing
will offer Members a baseline understanding of how the current
Code affects farmers, ranchers, and foresters, and how changes
to the Code might affect them moving forward.
Both the Ranking Member and I are CPAs, and many of our
colleagues in Congress are small business owners in their own
right. Each of us who has advised a client or managed a
business is keenly aware of the day-in and day-out challenges
of running a business, including the need to carefully manage
cash to pay suppliers; the challenge of financing repairs,
improvements, or expansion; and the relentless drive to build a
business that can be transitioned to the next generation.
While there are several parallels between agriculture and
other small businesses, few sectors are subject to as many
unknowns as farming and ranching. Weather, pests, constantly
changing consumer preferences, predatory trade practices of
foreign governments, and so much more all rob certainty from
producers. Agriculture is an industry of high fixed costs, lead
times that last an entire growing season or longer, and highly
variable returns combined with, historically, very tight
margins. As a result, managing tax liability is of paramount
importance.
To support producers, Congress has worked to soften the
negative impacts of inflexible tax rules that do not make sense
for agriculture. These changes, which often seek to align
taxable events with real world activities, help producers
manage their tax burden and ensure that they have the means to
continue farming and ranching.
As with tax reform changes from years past, the devil is
always in the details. While Chairman Brady and his colleagues
at Ways and Means are hard at work, many of the details have
yet to be ironed out. What we do know though is that tax reform
is coming and it holds a promise of dramatically increasing
economic growth for all of America in every walk of life.
Providing for a simpler, fairer Tax Code means that many
parts of the Tax Code may have to change. Actually, they will
have to change. While every individual component of tax reform
will have its supporters and detractors, these individual
proposals cannot be evaluated in a vacuum. I would ask my
colleagues to listen, ask questions, and learn today, but
reserve judgment on the components of tax reform until you see
the entire package.
I would like to, again, welcome our witnesses and thank
them for taking the time to be with here today.
[The prepared statement of Mr. Conaway follows:]
Prepared Statement of Hon. K. Michael Conaway, a Representative in
Congress from Texas
Good morning. I want to welcome you all to today's hearing
examining how the Tax Code impacts American agricultural producers.
Much like it did in 1985 and 1986, tax reform is poised to again
consume much of Washington's attention. Before that happens, today's
hearing will offer Members a baseline understanding of how the current
Tax Code affects farmers, ranchers, and foresters, and how changes to
the Code might affect them, going forward.
Both the Ranking Member and I are CPAs, and many of our colleagues
in Congress are small business owners in their own right. Each of us
who has advised a client or managed a business is keenly aware of the
day-in, day-out challenges of running a business, including the need to
carefully manage cash to pay suppliers; the challenge of financing
repairs, improvements, or expansion; and the relentless drive to build
a business that can be transitioned to the next generation.
While there are several parallels between agriculture and other
small businesses, few sectors are subject to as many unknowns as
farming and ranching. Weather, pests, constantly changing consumer
preferences, predatory trade practices of foreign governments, and so
much more all rob certainty from producers. Agriculture is an industry
of high fixed costs, lead times that last an entire growing season or
longer, and highly variable returns combined with historically very
tight margins. As a result, managing tax liability is of paramount
importance.
To support producers, Congress has worked to soften the negative
impacts of inflexible tax rules that do not make sense for agriculture.
These changes, which often seek to align taxable events with real world
activities, help producers manage their tax burden and ensure they have
the means to continue farming or ranching.
As with tax reform changes from years past, the devil is in the
details. While Chairman Brady and his colleagues at Ways and Means are
hard at work, many of the details have yet to be ironed out. What we do
know, though, is that tax reform is coming and it holds the promise of
dramatically increasing economic growth for all Americans in every walk
of life.
Providing for a simpler, fairer Tax Code means that many parts of
the Tax Code may have to change. While every individual component of
tax reform will have its supporters and detractors, these individual
proposals cannot be evaluated in a vacuum. I'd ask my colleagues to
listen, ask questions, and learn today, but reserve judgement on the
components of tax reform until we can see the entire package.
With that, I'd like to again welcome our witnesses and thank them
for taking the time to be with us here today.
With that, I now turn to the Ranking Member, Mr. Peterson, for any
comments he'd like to make.
The Chairman. And with that, I will recognize the Ranking
Member for any comments that he might have.
OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE
IN CONGRESS FROM MINNESOTA
Mr. Peterson. Thank you, Mr. Chairman. And I want to thank
the witnesses and the Members for being here today to testify.
As you said, tax reform and what happens with tax law is a
very important issue for agriculture and rural America. And we
need to keep in mind that beyond the farm bill, there are other
aspects of Federal policy that Congress may act on, there are
few others that will have the impact on producers as what we do
there on land and tax policy on those issues.
Like the Chairman said, I am a CPA. And I remember the days
back in the '70s when people would come by my office----
The Chairman. Which century was that?
Mr. Peterson. That was in the 1870s.
The Chairman. 1870s.
Mr. Peterson. And people would come in my office in
December and they would ask me to figure out what their net
income was, and then they would ask me how much equipment they
had to buy, so they wouldn't have to pay any tax. And this is
sometimes equipment they needed, but a lot of times it really
wasn't what they needed, but they had a seven percent tax
credit that time, tax----
The Chairman. Investment.
Mr. Peterson. Investment tax credit. And it was part of the
reason people got in trouble in the farm crisis. Unfortunately,
we have something going on today that is similar, with the
section 179 depreciation and the bonus depreciation, which
continues on at 50 percent, and I don't know when that expires.
Is that this year? It keeps going, does it?
The Chairman. It scales down.
Mr. Peterson. What? Next year?
The Chairman. It scales down.
Mr. Peterson. Anyway, my old partners tell me that they
have the same situation going on now that we had back then,
that people are buying stuff so they don't have to pay tax. And
I get that, and I made a living for quite a few years helping
people with that, but, as we get into this downturn in prices
and pressure on agriculture producers, you are going to see
people being more in a bind than they would have been because
of what they did in the tax area.
We need to be careful in what we do. Some of the ideas I
have heard, getting rid of interest deductions as opposed to
letting 100 percent expensing of all equipment and building, I
have some real questions about that in terms of what it is
going to do for agriculture, we need to be careful. This border
adjustment tax sounds good, but could potentially collapse our
export markets. We need to be really careful in what we do, and
be mindful of how this is going to impact agriculture and our
producers. Maybe we need to re-enact, bring up the fair tax
which eliminates the income tax altogether, and it changes the
incentive from buying things to get rid of tax, to saving to
get rid of tax. And that changes the whole mentality of it, I
was a cosponsor of that theme for many years but it kind of
died by the wayside.
The Chairman. Me too.
Mr. Peterson. Anyway, this is an important issue. It is
good that we have an opportunity to discuss it here in the
Agriculture Committee, and, hopefully something will get done
because the Tax Code does need to change, we do need to lower
the rates, we do need to address some of the complexity in the
system, and hopefully we can have some voice in that.
So thank you, Mr. Chairman. I yield back.
The Chairman. The gentleman yields back.
Major tax reform hasn't been done since 1987 because it is
hard. And I agree with the gentleman. I have cosponsored the
fair tax each time I have been in Congress as well because I do
think a dramatic change would be for the best, but you are
going to have to have a President run on that issue in order to
educate the people as to what is going on.
The chair requests that other Members submit their opening
statements for the record so witnesses may begin their
testimony to ensure there is ample time for questions.
Our first panel today is two of our fellow Members of the
Ways and Means Committee. We have Ms. Kristi Noem from South
Dakota, a former Member of the Agriculture Committee, much to
our regret she moved over to the Ways and Means Committee.
Kristi will go first, and then we have a fellow CPA, Lynn
Jenkins from Kansas, who will also be testifying this morning.
So with that, Kristi, you are recognized for 5 minutes.
STATEMENT OF HON. KRISTI L. NOEM, A REPRESENTATIVE IN CONGRESS
FROM SOUTH DAKOTA
Mrs. Noem. Well, thank you, Mr. Chairman, and thank you for
allowing me to appear before the Agriculture Committee today.
And, Ranking Member Peterson, the concerns that you just
expressed are some that we have debated in the Ways and Means
meetings that we have had on tax reform as well, and that is
one of the things that I have been grateful for. I have been
able to bring an agriculture perspective to those discussions,
talk about the industry, how it is highly leveraged at times
when producers are buying land with loans, then making loans to
purchase machinery, then having an operating loan every year
too. We have to be careful in what we do so that we keep their
operations viable. I appreciate you expressing those concerns,
and we will continue to work for a Tax Code that works for
everybody.
It is an honor, and it always has been an honor for me to
fight alongside of you for agriculture, and it was an honor for
me to serve on this Committee for many years. We advocated for
those who feed the world, and were able to pass a strong farm
bill in 2014. We all know there were challenges in getting that
legislation to the finish line, but we proved once again that
there is no job too hard that farmers can't do, and no task
that isn't worth doing for our agriculture industry that feeds
the world.
Today, we face another significant challenge and
opportunity with tax reform.
Just as the farm bill touches every single family's life,
because everyone eats, tax reform will impact everyone's life
because we all pay taxes in one way or another. I commend you
for holding today's hearing.
I know that some of the areas of the Tax Code
disproportionately and unfairly impact America's agriculture
community. This includes the death tax. As many of you know, my
family was hit with the death tax when my dad had an accident
on our family farm at the age of 49 years old. About a month
after he passed away, our family received a letter from the IRS
that said we owed money on land and machinery and cattle, and
we didn't have money in the bank. It was very difficult for us
to keep our family operation going. We took out a massive loan,
but it took me 10 years to pay off that loan. And since then I
have been active in making sure that we are advocating for
repealing the death tax. We weren't able to invest in our
operation and make the kind of improvements that we wanted to
because we had to pay on that loan every single year.
And many producers find themselves in a similar spot when
tragedy strikes their family, and that is why I have sponsored
legislation to repeal the death tax, and was glad that it was
included in the House Ways and Means tax reform Blueprint.
Additionally, what many don't quite realize is how highly
leveraged agriculture production is. Many farmers take out
loans every year only to put that money in the ground in the
form of seeds and fertilizer, and hope that that fall there
will be something to pick up and harvest so they can pay their
bills.
It is especially true for younger farms and younger farmers
who aren't established enough to cash-flow their own
operations. Ensuring that there is adequate cost recovery
mechanisms in the Tax Code is essential to attracting and
keeping younger producers on the family farm.
Some use a combination of interest and expensing for
operating notes and equipment purchases. Because land is a
principle input for agriculture, ensuring there continues to be
a cost recovery mechanism for land purchases remains a
priority. And all this said, Mr. Chairman, there is one
additional thing in common between the farm bill and tax
reform: provisions cannot be looked at in isolation. And I
encourage you to view tax reform as a comprehensive package
that is aimed to increase opportunity and growth for Americans
from all walks of life.
Mr. Chairman, nowhere in the country is the American dream
more alive than within agriculture. I stand ready to work with
you and Members of the Committee to make sure farmers and
ranchers can continue to pursue the American dream, and in
doing so, our great tradition of feeding the world.
It is great to be with all of you today. I loved serving on
this Committee. It is such a bipartisan group of folks who
really care about policy to secure a safety net for our farmers
and ranchers, but also recognize we feed the world. God bless
you for the work that you do, and use me as a resource as you
go forward and look at tax reform and how it impacts the
industry.
With that, Mr. Chairman, I will yield back.
The Chairman. The gentlelady yields back. We thank you,
Kristi, for being here.
Ms. Jenkins, 5 minutes.
STATEMENT OF HON. LYNN JENKINS, A REPRESENTATIVE IN CONGRESS
FROM KANSAS
Ms. Jenkins. Chairman Conaway, Ranking Member Peterson, and
honorable Members of the House Agriculture Committee, thank you
for the opportunity to testify before you this morning to
discuss the important topic of tax reform, and the potential it
has to help the agricultural economy and the rural way of life
in America.
Mr. Chairman, as fellow CPAs, I know that we both
understand the opportunity that tax reform can unlock in this
space. I would also like to echo the remarks of my colleague on
the House Ways and Means Committee, Congresswoman Noem,
regarding the importance of eliminating the death tax and
allowing interest deductibility for our farmers and ranchers.
I was raised on a dairy farm in Holton, Kansas, and so I
can speak with firsthand knowledge about the challenges and
rewards that come with farming. Ours was a family operation,
not at all different from other small businesses across
America, and as such, we had to balance work on the farm with
the complicated bookkeeping that goes along with that.
To make life easier for American families and businesses,
the Ways and Means Committee has embarked on an effort to
accomplish comprehensive tax reform for the first time since
1986. The guiding principles of tax reform will be beneficial
to the agriculture community. We plan to lower tax rates for
families and businesses, simplify a complex and burdensome Code
for filers, and encourage investment. We believe that these
principles will unburden American taxpayers and spur economic
growth.
Of particular interest to the Agriculture Committee is our
effort to lower tax rates for individuals, pass-through
businesses, and corporations. For individuals, this means
moving from our current system of seven marginal tax brackets
down to three, with rates at 12 percent, 25 percent, and 33
percent. For pass-through businesses, the rate would be 25
percent, and for corporations the rate would be 20 percent. In
addition, our plan will reduce complexity by repealing the
alternative minimum tax. The result here will be a significant
rate cut across the board, a lower tax burden for farmers and
ranchers, and simplification when filing.
The plan also provides businesses the ability of immediate
expensing of their investments. For the ag community this means
that purchases related to the business, like tractors,
combines, and other farm equipment, will be written-off in real
time for tax purposes as we move toward a cash-flow tax. This
means that we are doing away with complicated depreciation
schedules and uncertainty regarding extension of temporary tax
provisions. Additionally, this will make sense for family
farmers who already operate on a cash-flow basis by using the
cash accounting system. We believe that moving toward immediate
and full expensing would open greater opportunities for the
cash method of accounting.
I want to thank you all again for the opportunity to be
with you this morning. I look forward to working with each and
every one of you on this Committee to ensure that the interests
of rural America will be protected as we move forward with
comprehensive tax reform.
Thank you, and I yield back.
The Chairman. Well, I thank the gentlelady for yielding
back.
Agriculture is glad we have both of you on the Ways and
Means Committee as that Committee begins its work. We know how
much impact individual Members have on the Agriculture
Committee on the farm bill, and I am looking forward to having
you as advocates on behalf of ag interests on the Ways and
Means Committee in whatever path we walk on tax reform. With
that, thank you both for being here this morning.
And we will now transition to the second panel.
Well, we have a terrific second panel. The first panel set
the table well for where we go from here, so I would like to
welcome Ms. Patricia Wolff, the Senior Director for
Congressional Relations, American Farm Bureau Federation here
in Washington, D.C.; Mr. Doug Claussen who is a CPA and a
Principal at KCoe Isom, LLP, in Cambridge, Nebraska;
Mr. Chris Hesse, CPA, Principal of CliftonLarsonAllen, LLP,
Minneapolis, Minnesota; Mr. Guido van der Hoeven, Extension
Specialist/Senior Lecturer, Department of Agricultural and
Resource Economics, Raleigh, North Carolina; and Dr. James
Williamson, Economist, United States Department of Agriculture,
Economic Research Service, here in D.C.
Ms. Wolff, your 5 minutes will begin when you want to.
Thank you.
STATEMENT OF PATRICIA A. WOLFF, SENIOR DIRECTOR,
CONGRESSIONAL RELATIONS, AMERICAN FARM BUREAU FEDERATION,
WASHINGTON, D.C.
Ms. Wolff. Chairman Conaway, Ranking Member Peterson, and
Members of the Committee, thank you for scheduling this hearing
on agriculture and tax reform. This discussion of Tax Code
provisions that are valuable to farmers and ranchers is
important as the 115th Congress begins to rewrite our nation's
Tax Code.
My name is Pat Wolff, and I serve as the American Farm
Bureau Federation's tax policy specialist. Farm Bureau is a
general farm organization with nearly six million families who
grow, raise, or harvest all commodities commercially produced
in our country. Farm Bureau appreciates the opportunity to
highlight the Tax Code provisions important to the long-term
financial success of farm and ranch businesses.
Farms and ranches operate in a world of uncertainty. Each
day our members face unpredictable commodity and product
markets, fluctuating input prices, uncertain weather, and
insect and disease outbreaks. Clearly, running a farm or ranch
business is challenging under the best of circumstances, and
these challenges can lead to significant financial uncertainty.
Farmers and ranchers need a Tax Code that recognizes that our
industry faces unique financial risks. Tax priorities and
policies are needed that support high-risk, high-input,
capital-intensive businesses like farms and ranches that
predominantly operate as sole proprietors and pass-through
entities.
Congress has acknowledged these unique business challenges
by including provisions in the Tax Code to allow farmers and
ranchers to handle their cash-flow challenges by leveling their
incomes and matching income with expenses.
Farm Bureau has identified several of these provisions as
critical components of any tax reform plan. And I will mention
these in a minute, but these are a comprehensive list of
provisions that help farmers. What is important to take away
from today's hearing is that farmers and ranchers need
financial and tax management tools to weather turbulent
financial times.
Before I talk about the tax provisions that Farm Bureau has
identified as priorities, I need to make an important point
about effective tax rates. Lower tax rates coupled with base-
broadening provisions will provide the foundation for any major
tax overhaul. Unless farmers and ranchers continue to have
access to a menu of tax provisions that help them deal with the
cyclical and unpredictable nature of their businesses, there is
a potential that even with lower tax rates, there could be an
increase in taxes that farmers and ranchers pay.
Now I will turn to the items that Farm Bureau has
identified as priorities. First, cost recovery. Farm and ranch
businesses have high input costs. Immediate expenses reduces
the taxes in the purchase year, providing readily available
funds for buying production supplies, replacing livestock,
upgrading equipment, and hopefully for expanding their
businesses. Second, cash accounting. Cash accounting is the
preferred and far-and-away the most chosen method of accounting
for farmers and ranchers. It allows them to cash-flow by
matching income with expenses, and aids in tax planning. Third,
the interest deduction. Farmers and ranchers rely almost
exclusively on borrowed money to buy production inputs,
equipment, land, and buildings. The interest they pay on their
loans is a legitimate business expense and should be
deductible. Fourth, estate taxes. Estate taxes can disrupt the
transition of farm and ranch businesses from one generation to
the next. They should be repealed, and unlimited stepped-up
basis, another critical element in preserving family farm
operations, should continue. Fourth, capital gains taxes.
Production agriculture requires large investments in land and
buildings that are held for long periods of time. Lower tax
rates on capital gains recognizes the risk that is involved
with long-term business investments, and should continue.
Fifth, like-kind exchanges. Like-kind exchanges help farmers
and ranchers operate efficient businesses by deferring taxes
when they sell, and then purchase new or better land,
livestock, and equipment. This allows them to improve and grow
their businesses faster.
In closing, I would like to thank the Committee for holding
this important hearing about agriculture and tax reform. Farm
Bureau encourages the Committee to actively advocate for a Tax
Code that helps farmers and ranchers navigate the uncertain and
unpredictable nature of their businesses.
[The prepared statement of Ms. Wolff follows:]
Prepared Statement of Patricia A. Wolff, Senior Director, Congressional
Relations, American Farm Bureau Federation, Washington, D.C.
Chairman Conaway, Ranking Member Peterson, and Members of the
Committee, thank you for scheduling this hearing on Agricultur[e] and
Tax Reform: Opportunities for Rural America. It is important for the
Committee on Agriculture to shed light on tax provisions important to
farmers and ranchers as the 115th Congress begins to rewrite our
nation's Tax Code.
My name is Pat Wolff and I serve as Farm Bureau's tax policy
specialist. Farm Bureau is the country's largest general farm
organization, with nearly six million member families and representing
nearly every type of crop and livestock production across all 50 states
and Puerto Rico. Farm Bureau appreciates the opportunity to highlight
Tax Code provisions important to the long-term financial success of
farm and ranch businesses.
Farms and ranches operate in a world of uncertainty. From
unpredictable commodity and product markets to fluctuating input
prices, from uncertain weather to insect or disease outbreaks, running
a farm or ranch business is challenging under the best of
circumstances. Farmers and ranchers need a Tax Code that recognizes the
financial challenges that impact agricultural producers.
Farm Bureau supports tax laws that help the family farms and
ranches that grow America's food and fiber, often for rates of return
that are modest compared to other businesses['] opportunities. What is
needed are tax policies that support high-risk, high-input, capital-
intensive businesses like farms and ranches that predominantly operate
as sole proprietors and pass-through entities.
The House of Representatives is moving forward with comprehensive
tax reform designed to spur growth of our nation's economy. Many of the
provisions of the tax reform Blueprint will be beneficial to farmers,
including reduced income tax rates, reduced capital gains taxes,
immediate expensing for all business inputs except land and the
elimination of the estate tax. The proposed loss of the deduction for
business interest expense, however, is a cause for concern. The
Blueprint can be improved by guaranteeing the continuation of stepped-
up basis, preserving cash accounting and maintaining like-kind
exchanges.
The testimony that follows focuses on and provides additional
commentary on the tax reform issues most important to farmers and
ranchers.
Lower Effective Tax Rates Will Benefit Farm and Ranch Businesses
Farm Bureau supports reducing tax rates and views this as the most
important goal of tax reform. Tax reform must be comprehensive and
treat farm and ranch businesses that operate as individuals, pass-
through businesses and corporations fairly. More than 94 percent of
farms and ranches are taxed under IRS provisions affecting individual
taxpayers. Tax reform that fails to treat sole proprietors,
partnerships and S corporations fairly will not help, and could even
hurt, the bulk of agricultural producers who operate outside of the
corporate Tax Code.
While lower tax rates are important, the critical feature for
farmers and ranchers is the effective tax rate paid by farm and ranch
businesses. Tax reform that lowers rates by expanding the base should
not increase the overall tax burden (combined income and self-
employment taxes) of farm and ranch businesses. Because profit margins
in farming and ranching are tight, farm and ranch businesses are more
likely to fall into lower tax brackets. Tax reform plans that fail to
factor in the impact of lost deductions for all rate brackets could
result in a tax increase for agriculture.
Farming and ranching is a cyclical business where a period of
prosperity can be followed by 1 or more years of low prices, poor
yields or even a weather disaster. Tax Code provisions like income
averaging allow farmers and ranchers to pay taxes at an effective rate
equivalent to a business with the same aggregate but steady revenue
stream. Farm savings accounts would accomplish the same object[ive]
plus allow a fa[r]mer or rancher to reserve income in a dedicated
savings account for withdrawal during a poor financial year. Currently
one of the main mechanisms farmers have to move money from one year to
the next is by purchasing new equipment or other inputs. Farm savings
accounts would give farmers much more flexibility in money management.
Accelerated Cost Recovery Helps Farmers Remain Efficient
Expensing allows farm and ranch business to recover the cost of
business investments in the year a purchase is made. Because production
agriculture has high input costs, Farm Bureau places a high value on
the immediate write-off of equipment, production supplies and pre-
productive costs.
The value of expensing has been widely acknowledged by Congress as
recently as 2015 with passage of the PATH Act, which made permanent the
$500,000 level of Sect. 179 small businesses expensing. The Tax Code
also provides immediate cost recovery through bonus depreciation and
through long standing provisions that allow for the expensing of soil
and water conservation expenditures, expensing of the costs of raising
dairy and breeding cattle and for the cost of fertilizer and soil
conditioners like lime.
When farmers are not allowed immediate expensing they must
capitalize purchases and deduct the expense over the life of the
property. Accelerated deductions reduce taxes in the purchase year,
providing readily available funds for upgrading equipment, to replace
livestock, to buy production supplies for the next season and for
farmers to expand their businesses.
Cash Accounting Helps Farm and Ranch Businesses to Cash-Flow
Cash accounting is the preferred method of accounting for farmers
and ranchers because it allows them to match income with expenses and
aids in tax planning. Farm Bureau supports the continuation of cash
accounting.
Cash accounting allows farmers and ranchers to improve cash-flow by
recognizing income when it is received and recording expenses when they
are paid. This provides the flexibility farmers need to plan for major
business investments and in many cases provides guaranteed availability
of some agricultural inputs.
Under a progressive tax rate system, farmers and ranchers, whose
incomes can fluctuate widely from year to year, will pay more total
taxes over a period of time than taxpayers with more stable incomes.
The flexibility of cash accounting also allows farmers to manage their
tax burden on an annual basis by controlling the timing of revenue to
balance against expenses and target an optimum level of income for tax
purposes.
Loss of cash accounting would create a situation where a farmer or
rancher might have to pay taxes on income before receiving payment for
sold commodities. Not only would this create cash-flow problems, but it
also could necessitate a loan to cover ongoing expenses until payment
is received. The use of cash accounting helps to mitigate this
challenge by allowing farm business owners to make tax payments after
they receive payment for their commodities.
Deducting Interest Expense Is Important for Financing
Debt service is an ongoing and significant cost of doing business
for farmers and ranchers who must rely on borrowed money to buy
production inputs, vehicles and equipment, and land and buildings.
Interest paid on these loans should be deductible because interest is a
legitimate business expense.
Farm and ranch businesses are almost completely debt financed with
little to no access to investment capital to finance the purchase of
land and production supplies. In 2015, all but five percent of farm
sector debt was held by banks, life insurance companies and government
agencies. Without a deduction for interest, it would be harder to
borrow money to purchase land and production inputs and the agriculture
sector could stagnate.
Land has always been farmers' greatest assets, with real estate
accounting for 79 percent of total farm assets in 2015. Since almost
all land purchases require debt financing, the loss of the deduction
for mortgage interest would make it more difficult to cash-flow loan
payments and could even make it impossible for some to secure financing
at all. The need for debt financing is especially critical for new and
beginning farmers who need to borrow funds to start their businesses.
Repealing Estate Taxes Will Aid in Farm Trans[it]ions
Estate taxes disrupt the transition of farm and ranch businesses
from one generation to the next. Farm Bureau supports estate tax
repeal, opposes the collection of capital gains taxes at death and
supports the continuation of unlimited stepped-up basis.
Farming and ranching is both a way of life and a way of making a
living for the millions of individuals, family partnerships and family
corporations that own more than 99 percent of our nation's more than
two million farms and ranches. Many farms and ranches are multi-
generation businesses, with some having been in the family since the
founding of our nation.
Many farmers and ranchers have benefited greatly from Congressional
action that increased the estate tax exemption to $5 million indexed
for inflation, provided portability between spouses, and continued the
stepped-up basis. Instead of spending money on life insurance and
estate planning, farmers are able to upgrade buildings and purchase
equipment and livestock. And more importantly, they have been able to
continue farming when a family member dies without having to sell land,
livestock or equipment to pay the tax.
In spite of this much-appreciated relief, estate taxes are still a
pressing problem for some agricultural producers. One reason is that
the indexed estate tax exemption, now $5.49 million, is still catching
up with recent increases in farmland values. While increases in
cropland values have moderated over the last 3 years, cropland values
remain high. On average cropland values are 62 percent higher than they
were a decade ago. As a result, more farms and ranches now top the
estate tax exemption. With 91 percent of farm and ranch assets
illiquid, producers have few options when it comes to generating cash
to pay the estate tax.
Reduced Taxation of Capital Gains Encourages Investment
The impact of capital gains taxes on farming and ranching is
significant. Production agriculture requires large investments in land
and buildings that are held for long periods of time during which land
values can more than triple. Farm Bureau supports reducing capital
gains tax rates and wants an exclusion for farm land that remains in
production.
Capital gains taxes are owed when farm or ranch land, buildings,
breeding livestock and timber are sold. While long-term capital gains
are taxed at a lower rate than ordinary income to encourage investment
and in recognition that long-term investments involve risk, the tax can
still discourage property transfers or alternatively lead to a higher
asking price.
Land and buildings typically account for 79 percent of farm or
ranch assets. The current top capital gains tax is 20 percent. Because
the capital gains tax applies to transfers, it provides an incentive to
hold rather than sell land. This makes it harder for new farmers and
producers who want to expand their business, say to include a child, to
acquire property. It also reduces the flexibility farm and ranches need
to adjust their businesses structures to maximize use of their capital.
Stepped-Up Basis Reduces Taxes for the Next Generation of Producers
There is also interplay between estate taxes and capital gains
taxes: stepped-up basis. Step-up sets the starting basis (value) of
land and buildings at what the property is worth when it is inherited.
Capital gains taxes on inherited assets are owed only when sold and
only on gains over the stepped-up value. If capital gains taxes were
imposed at death or if stepped-up basis were repealed, a new capital
gains tax would be created and the implications of capital gains taxes
as described above would be magnified.
Stepped-up basis is also important to the financial management of
farms and ranches that continue after the death of a family member. Not
only are land and buildings eligible for stepped-up basis at death but
so is equipment, livestock, stored grains, and stored feed. The new
basis assigned to these assets resets depreciation schedules providing
farmers and ranchers with an expanded depreciation deduction.
Like-Kind Exchanges Help Ag Producers Stay Competitive
Like-kind exchanges help farmers and ranchers operate more
efficient businesses by allowing them to defer taxes when they sell
assets and purchase replacement property of a like-kind. Farm Bureau
supports the continuation of Sect. 1031 like-kind exchanges.
Like-kind exchanges have existed since 1921 and are used by farmers
and ranchers to exchange land and buildings, equipment, and breeding
and production livestock. Without like-kind exchanges some farmers and
ranchers would need to incur debt in order to continue their farm or
ranch businesses or, worse yet, delay mandatory improvements to
maintain the financial viability of their farm or ranch.
The Chairman. Thank you, Pat.
Doug, 5 minutes.
STATEMENT OF DOUG CLAUSSEN, CPA, PRINCIPAL, KCOE ISOM,
LLP, CAMBRIDGE, NE
Mr. Claussen. Good morning, Chairman Conaway, Ranking
Member Peterson, Members of the Committee. Thank you for the
opportunity to appear before you today.
My name is Doug Claussen, and I am a certified public
accountant and principal at KCoe Isom. We are a
national leader in providing accounting and consulting
expertise to American farmers, ranchers, and ag-related
businesses. I have more than 20 years of experience working
with all facets of agriculture.
I will discuss several issues with you today, focusing
primarily around Tax Code provisions that are of particular
importance to farmers, livestock producers, and ag-related
businesses. In June of last year, House Ways and Means
Committee leadership unveiled a document entitled, Better Way
for Tax Reform, and this is commonly referred to as the
Blueprint. This Blueprint lays out the Committee's tax reform
priorities, which include streamlining and simplifying the
existing Tax Code and the lowering of overall tax rates for
individuals and businesses. KCoe Isom supports Tax Code
simplification and rate reductions. We applaud Speaker Ryan and
Chairman Brady for their efforts to advance tax reform.
The process of streamlining the Code likely means the
elimination of many of the provisions that farmers have used to
manage their tax burden, and smooth out income volatility. I
will talk about the importance of three provisions in
particular; cash accounting, interest expense deductibility,
and loss carryback provisions.
I begin with cash accounting. Although the elimination of
cash accounting for farmers was not included in the Blueprint,
it has been proposed by Ways and Means Committee leadership as
recently as 2013, and it would generate significant tax
revenues. In that earlier reform draft, the Committee proposed
eliminating cash basis accounting for all entities with annual
gross revenues in excess of $10 million. This would have had
devastating impacts on affected farmers and livestock
producers.
Under current law, there are two primary methods of
accounting for tax purposes; tax and accrual. Under cash basis
accounting, tax obligations are created only after cash has
actually been received. Conversely, accrual basis accounting
results in tax obligations as soon as the taxpayer has the
right to receive payment. In short, with accrual accounting,
farmers could find themselves paying taxes on income that they
have not yet received. Farmers have long utilized the cash
method of accounting to provide a consistent tax liability from
year to year. Just to clarify, over a full economic cycle,
taxes will be paid on all of a farm's income, regardless of the
accounting method used. Cash accounting is a flexibility tool,
not a tax avoidance tool. Fortunately, then-Chairman Camp
backed away from this cash to accrual proposal for farmers. I
am confident that was the right decision, and I urge you to
ensure farmers continue to have access to this tool as you
consider comprehensive tax reform this year.
Now to discuss the provision the Blueprint does contain,
which is the limit on the deduction for interest payments as a
business expense, except as to offset interest income. Ag
operations are highly dependent on credit, both for their day-
to-day operations and long-term expansion. As such, most U.S.
farm operations incur a substantial annual interest expense,
yet are seldom structured to generate interest income to offset
it. We also need to consider the purchase of farmland with debt
capital. According to a 2014 survey conducted by the USDA,
approximately 21 million acres of farmland are expected to be
sold before 2019, virtually all of it through debt financing.
The Blueprint recognizes that this provision will uniquely
impact certain industries, and that exemptions should be made.
Specifically, it states the, ``Ways and Means Committee will
work to develop special rules with respect to interest expense
for financial services companies . . .''. We believe
agriculture is also uniquely impacted, and support special
rules exempting farmers from this provision.
The third provision I would like to discuss is treatment of
net operating losses. The Blueprint would prohibit carrybacks
of net operating losses, and would limit net operating loss
carryforwards to 90 percent of the net taxable amount for any
year. As with cash accounting, carrybacks and carryforwards are
tools widely utilized by farmers to stabilize their volatile
revenue streams and tax liabilities. Without a loss carryback
provision the volatility of the net farm income puts farmers in
a position of paying tax in the highest brackets in the more
profitable years, then when they suffer significant losses
there is minimal tax benefit if they are forced only to carry
them forward to future years.
Again, I appreciate the opportunity to testify before this
panel this morning, and for your commitment to American
agriculture. Comprehensive tax reform has the potential to
deliver significant benefits to ag producers and to all of
rural America. To date, we at KCoe Isom have worked
with several farmers and industry groups to perform a detailed
analysis on the implications of tax reform, and we are
preparing to dive into the Ways and Means Committee's draft
proposal we expect to see in the coming weeks. We intend to be
an active participant throughout this process, and I offer
myself and my firm as a resource to all of you as you consider
these very important tax questions in the months ahead.
I welcome any questions the Committee might have, and thank
you again for this opportunity.
[The prepared statement of Mr. Claussen follows:]
Prepared Statement of Doug Claussen, CPA, Principal, KCoe Isom
LLP, Cambridge, NE
Chairman Conaway, Ranking Member Peterson, Members of the
Committee, thank you for the opportunity to appear before you today. My
name is Doug Claussen and I am a certified public accountant and
principal at KCoe Isom, LLP. We are a national leader in
providing accounting, financial, succession planning, business
analysis, sustainability guidance, and government affairs consulting
expertise to American farmers, ranchers, and ag-related businesses. I
have more than 20 years of experience working for agribusinesses and
cooperatives involved in beef production, dairy operations, grain
production, and marketing.
KCoe Isom traces its roots back more than 80 years, to
rural communities in the Central Great Plains and Central California
where agriculture and food production are predominant industries. Two-
thirds of my firm's business derives from financial and tax accounting
for agricultural producers and ag-related companies. The firm is
solidly embedded throughout the food-supply chain, working with
producers, input suppliers, processors, packagers, distributors,
biofuel manufacturers, equipment dealerships, landowners, and lenders,
and we seek to positively impact the future of farming and food
production in America. In short, we are experts in the Tax Code and how
it impacts farmers, processors and related rural businesses.
I will discuss several issues with you today, focusing primarily
around Tax Code provisions that are of particular importance to
farmers, livestock producers, and ag-related businesses.
In June of last year, House Ways and Means Committee leadership
unveiled a document entitled a ``Better Way for Tax Reform,'' commonly
referred to as the ``Blueprint.'' This Blueprint lays out the basic
contours of the Committee's tax reform priorities, which includes a
significant streamlining and simplification of the existing Tax Code
and a lowering of overall tax rates for individuals and businesses.
KCoe Isom supports Tax Code simplification and rate reductions,
provided Congress does not raise the effective burden on agriculture.
We applaud Speaker Ryan and Chairman Brady for their efforts to advance
tax reform and we look forward to seeing and analyzing the bill.
Of course, the process of streamlining the Code likely means the
elimination of many of the provisions that farmers and ranchers have
utilized over the years to manage and minimize their tax burden and
smooth out income volatility. I will begin by talking about the
importance of three provisions in particular: cash accounting for
farmers, interest expense deductibility, and loss carryback provisions.
Cash Accounting
I will begin with cash accounting. Although the elimination of cash
accounting for certain farmers and ranchers was not included in the
Blueprint, it has been proposed by Ways and Means Committee leadership
as recently as 2013--and would generate significant tax revenues--so I
will address it here. In that earlier reform draft, the Committee
proposed eliminating cash basis accounting for all entities, including
farmers, with annual gross revenues in excess of $10 million. This
would have had devastating impacts on affected farmers and livestock
producers.
Under current law, there are two primary methods of accounting for
tax purposes: cash and accrual. Under cash basis accounting, taxes
obligations attach only after cash has actually been collected or bills
have actually been paid. Conversely, accrual basis accounting results
in tax obligations as soon as the taxpayer has the right to receive
payment, even if that payment will not actually be received for several
months or even several years. In short, under accrual accounting,
farmers and ranchers could find themselves paying taxes on income they
have not received, creating significant cash-flow challenges.
Farmers and ranchers have long utilized the cash method of
accounting to balance out the significant price and production
volatility that is inherent in agriculture. This provides them with a
more consistent tax liability and cash-flow from year to year. A farm
operation using cash accounting can defer income to later years which
enables it to manage working capital and avoid paying significant taxes
at a higher marginal tax rate in an exceptional revenue year. Given
agriculture's inherent income volatility, this preserved capital is
often a vital lifeline during periods of low profitability which, as we
know, can last for years.
Many of my clients are cattle feeders, and I would like to put some
relatable numbers on this: This change to accrual would be forced upon
a cattle feeder that, in a given year, markets 6,500 head of 1,300
pound cattle at a sales price of $1.19 per pound. We can agree that
this example does not represent a particularly large cattle feeder or a
high fat-cattle price. And depending on the cost of feed and other
inputs, this feeder may very well have finished the year in the red. If
commodity prices increase, and I know we all hope they do, such a rule
would become increasingly applicable and force even smaller producers
into accrual accounting.
Additionally, aggregation rules extend this requirement to
operations smaller than $10 million. The aggregation rules are based on
the common employer rules, which determine whether multiple businesses
have to provide similar benefits to all employees of the businesses. As
a result, farm and ranch operations with revenues below $10 million
that are aggregated with other businesses under a common employer could
be required to use accrual accounting as well.
In response to this cash-to-accrual accounting proposal,
KCoe Isom created a coalition called Farmers for Tax Fairness
to oppose such a change. Through this effort, we commissioned a study
by Inform Economics to study the impacts on agriculture, and they
concluded that it would:
Reduce equity in farm and livestock operations by as much as
$4.84 billion;
Reduce working capital in agriculture by as much as $12.1
billion;
Change the way farms are allowed to manage their capital
each year, leading to increased financial volatility;
Increase interest expenses due to higher short-term lending
needs;
Decrease after-tax purchasing capacity; and
Increase the record-keeping burden for farm managers.
And keep in mind, over a full profitability cycle, a farmer will
pay taxes on all of his farm's income regardless of the accounting
method used. Cash accounting is solely a flexibility tool, not a tax
avoidance tool.
Fortunately, then-Chairman Camp heard our voices and backed away
from this cash-to-accrual proposal for agriculture. I am confident that
was the right decision, and I urge you to ensure farmers and ranchers
continue to have access to this vital tool as you consider
comprehensive tax reform this year.
Interest Deduction
Now to discuss a provision the Blueprint does contain. Because one
of its primary goals is to simplify and streamline the Code, many
provisions popular with farmers and ranchers are subject to change or
elimination. Among these is the provision to limit the deduction for
interest payments as a business expense. The Blueprint advocates
eliminating the tax deduction for interest expenses, except as an
offset to interest income. As we know, ag operations are highly
dependent on credit, both for their day-to-day operations and long-term
expansion. As such, most U.S. farm operations incur a substantial
annual interest expense, yet are seldom structured to generate interest
income to offset it.
In addition to considering annual farm operating loans, we also
need to understand the purchase of farmland with debt capital.
According to a 2014 survey conducted by the USDA, ten percent of U.S.
farmland is expected to change hands by 2019 and approximately 21
million acres of farmland are expected to be sold over that same time
period, virtually all of it through debt financing.
Given this information, consider the following example:
A farmer purchases 160 acres of land at $10,000 per acre for a
total cost of $1.6 million. (For clarity, the cost of the farmland
itself is not deductible under current tax law or under the Blueprint.)
The farmer chooses to finance $1 million of that purchase on a 20 year
note at four percent interest. During the 20 year term of the loan, the
farmer would pay more than $471,000 in interest expense. Assuming a 40
percent tax rate, current law allows for an income tax savings of
$188,000 due to the interest expense deduction. Even assuming a
Blueprint-lowered 33 percent income tax rate, the tax savings would
still be $155,000 if he were able to deduct the interest expense as a
business expense. As you can see, the virtual elimination of interest
expense deductions for farmers and ranchers would have a significant
negative impact on their cash-flow and on their ability to make large
purchases such as land and machinery.
The Blueprint recognizes that this provision will uniquely impact
certain industries and that targeted exemptions may be appropriate.
Specifically, it states that the ``Ways and Means Committee will work
to develop special rules with respect to interest expense for financial
services companies, such as banks, insurance, and leasing, that will
take into account the role of interest income and interest expense in
their business models.'' KCoe Isom believes agriculture is as
uniquely impacted as the financial services industry and supports
special rules exempting it from this provision as well.
One of the motivations behind this rule is to equalize the tax
treatment of debt and equity financing, but equity financing is not a
realistic option for most ag operations. Very few farmers want to bring
investors into their operations and investors have generally been
disinterested in agriculture, given its structure and volatility.
What's more, farmers with annual incomes below $500,000 already have
access to immediate expensing so, for them, this interest deduction
limitation would not be offset by the Blueprint's immediate expensing
benefit.
Loss Carryback and Carryforward Provisions
The third provision I would like to discuss is the elimination of
loss carrybacks and limitation on loss carryforward. The Blueprint
would prohibit carrybacks of net operating losses and would limit net
operating loss carryforwards to 90 percent of the net taxable amount
for any year. As with cash accounting, carrybacks and carryforwards are
tools widely utilized by farmers and ranchers to stabilize their
volatile revenue streams and tax liabilities and preserve working
capital for lean economic times.
According to USDA's 2017 Farm Sector Income Forecast, net farm
income is forecast at $62.3 billion for 2017, which is down 8.7 percent
compared to 2016. The calendar year 2016 net farm income forecasts are
$68.3 billion, which is down 15.6 percent from the 2015 levels. For
comparison, the net farm income for 2013 was $123.7 billion. The 2017
forecast is essentially \1/2\ of the net farm income from 2013, just 4
years later.
Given this volatility in net farm income, farmers should have the
option to level-out tax liabilities over an extended period of time.
Without a loss carryback provision, the volatility of net farm income
puts farmers in a position of paying tax in the highest brackets in the
more profitable years. Then when they suffer significant losses, there
is minimal tax benefit because they are forced to carry them forward to
future years.
Other Provisions
I'd also like to briefly point out some of the beneficial
provisions in the Blueprint that would provide meaningful tax benefits
to farm and ranch operations. The positive impacts of lower tax rates
on individual, pass-through, and corporate earnings would provide a
clear benefit to farmers, ranchers, and the entire economy. Also, given
the capital intensity of agriculture, immediate expensing of capital
purchases would be used extensively by farmers and ranchers, as well as
by many other industries that sell capital goods in rural areas.
Finally, the elimination of the estate tax would make succession
planning for farmers, ranchers and other rural small business owners
significantly less complex and help ensure that no Federal tax
liability is imposed upon death. That said, based on analysis
KCoe Isom has performed, the elimination of that Code section
will likely impact and benefit very few farm operations.
This is due to several factors, the most notable of which are: (1)
the sophisticated planning and business structure tools that are
available to farm estates to minimize or avoid the estate tax; and (2)
the recent increase in the exemption, which means that few estates are
subject to it, even given today's relatively high land values.
Fortunately this will continue to be true in the future, given
Congress' decision to index that exemption to inflation.
In my opinion, a more important consideration is the preservation
of provisions that allow the heirs of an estate to receive a step-up in
the basis of the property they inherit. Discontinuing this benefit,
thereby making the original purchase price of land the basis for
capital gains calculations, even if it was generations ago, has the
potential to create massive tax liability for the heirs when they
ultimately sell the land. The tax due on the sale of farmland could
discourage land sales, which would make it more difficult for young
farmers to get started.
Conclusion
Again, I appreciate the opportunity to testify before this panel
this morning, and for your stalwart commitment to American agriculture.
Comprehensive tax reform has the potential to deliver significant
benefits to ag producers and to all of rural America, but I think it is
important to understand that the current Tax Code has provisions that
are very beneficial to agriculture--many uniquely so. Therefore, before
agriculture as an industry lends its support to any reform proposal, it
should closely analyze the entire package to ensure that, taken as a
whole, it works to bolster the viability and profitability within the
sector.
To date, we at KCoe Isom have worked with several farmers
and industry groups to perform detailed analyses on the implications of
tax reform. We are sharpening our pencils to dive into the Ways and
Means Committee's draft proposal we expect to see in the coming weeks.
We intend to be an active participant throughout this process, and I
offer myself and my firm as a resource to all of you as you consider
these very important tax questions in the months ahead.
I welcome any questions the Committee might have, and thank you
again for this opportunity.
The Chairman. All right, Doug, thank you.
Chris, 5 minutes.
STATEMENT OF CHRISTOPHER W. HESSE, CPA, PRINCIPAL,
CliftonLarsonAllen, LLP, MINNEAPOLIS, MN
Mr. Hesse. Mr. Chairman, distinguished Members of the
Committee, I am Chris Hesse, a CPA and Principal of
CliftonLarsonAllen, LLP. I serve in the national office
delivering tax planning and research services throughout our
firm and to other CPAs, from Omak, Washington, to Sebring,
Florida, and from Los Angeles to Boston. We also prepare and
deliver educational materials to agricultural CPAs and tax
preparers throughout the country.
My family farms in eastern Washington State. I was the
first in my line to leave the farm, but my older son and nephew
are today farming over 2,000 irrigated acres, and another 3,000
dryland acres. I have served on Washington State Farm Bureau
Boards and as a county Farm Bureau President.
We commend the Committee for holding this hearing to focus
attention to the tax provisions important to agriculture. The
cash method of accounting is indeed critical for farmers and
ranchers. It was our client, 20 years ago, that received a bill
from the IRS for $100,000 on taxable income of $15,000, all due
to the alternative minimum tax that started this. With Farm
Bureau's help, we got that law changed, a 10 year retroactive
repeal provision.
On the income side, agricultural tax provisions include the
ability to sell product using the installment method, so as to
separate the timing of the sale event and the recognition of
income for tax purposes. I sell corn today when the price is
high, and I agree to receive payment next year. The
coordination of Commodity Credit Corporation loans with income
tax is so that a farmer may choose to report loan receipts as
taxable income in the year received, or to treat the loans as
true loans. A farmer may defer the recognition of crop
insurance income to the subsequent year. Livestock sales are
likewise provided various deferral opportunities for weather
and disease events. Important to the list is the Section 1031
exchange because the farmer has not cashed out her investment.
There is a discharge of debt income exclusion available for
farmers, and there are others.
On the expenditure side of the ledger, farmers use
accounting methods and depreciation provisions to help manage
the tax liability. Section 179, the expensing of equipment: the
cost of one combine may exceed $400,000. Fifty percent bonus
depreciation on original use farm assets: farmers may deduct
the cost of raising livestock. Farmers may deduct the cost of
raising crops, except for those crops such as vineyards and
orchards which have a pre-productive period of more than 2
years. The domestic production ag activities deduction reduces
the overall tax rate from growing and production activities.
Although fertilizer and soil conditioning expenses benefit the
soil over several years, a farmer may deduct those costs in the
year purchased. Soil and water conservation expenditures may be
deducted in the year paid, to encourage farmers to use
techniques to reduce erosion and conserve moisture. Farming is
capital-intensive. Interest expense deductions are important,
as Mr. Claussen has testified. Farmers may deduct prepaid farm
supplies, within limits. This allows farmers to ensure the
supply of needed inputs, such as chemicals, fertilizers, and
seeds. Farmers may deduct as a charitable contribution up to 50
percent of the value of apparently wholesome food given for the
benefit of the needy.
We have covered income and expenses, and there are also tax
computation provisions for which farmers qualify. Farmers need
not pay estimated taxes if the individual farm return is filed
by March 1. Farm income averaging allows farmers an imperfect
method of reducing the effect of income spikes. Farmers have a
net operating loss carryback period of 5 years, rather than the
2 year provision applicable to other taxpayers.
Last, I thank the House Agriculture Committee for
contacting the USDA to clarify the income threshold for
partnerships and S corporations for qualifying for various ag
program payments. These subsidy programs are keyed off of
adjusted gross income. That term doesn't translate well for
farms which operate as corporations or other limited liability
entities. Your involvement fixed an error in that guidance.
Thank you for your time, and I look forward to addressing
your questions.
[The prepared statement of Mr. Hesse follows:]
Prepared Statement of Christopher W. Hesse, CPA, Principal,
CliftonLarsonAllen, LLP, Minneapolis, MN
Good morning, Chairman Conaway, Ranking Member Peterson, and
distinguished Members of the Committee. I am Chris Hesse, a CPA and
principal of CliftonLarsonAllen. CLA is a professional services firm
that combines wealth advisory, outsourcing, and public accounting
capabilities to help clients succeed professionally and personally. I
serve in the national office, delivering tax planning, education and
research services throughout our firm, from Omak, Washington to
Sebring, Florida and from Los Angeles to Boston, and all areas in
between.
Although I come to you today from Minneapolis, my family farms in
Eastern Washington. I was the first in my line to leave the farm, but
today, my older son and nephew are farming over 2,000 irrigated acres
and another 3,000 dryland acres. I have served on Washington State Farm
Bureau boards and as a county Farm Bureau President.
Part of my work today is to prepare and deliver educational
materials to agricultural CPAs and tax preparers throughout the
country. Our purpose is to raise the level of awareness of the many tax
provisions benefiting farmers and ranchers. Today I will highlight some
of the most important provisions for you.
I'd like to thank the Committee for holding this hearing to focus
attention to the tax provisions important to agriculture. Special tax
provisions for farmers and ranchers acknowledge the challenges they
face in providing food for United States consumers and our export
market. Agricultural producers are uniquely subject to fluctuations in
weather, not only within the United States but also across the globe.
Another country's drought may substantially reduce available supplies
of commodities and foodstuffs worldwide, increasing the demand and
price for United States products. Similarly, bumper crops in other
parts of the world increase the supply and decrease the price for our
products, oftentimes below the cost of production. Various programs
help reduce the risks associated with weather events, disease, and
fluctuating markets. Since the Internal Revenue Code was enacted in
1913, various tax provisions have recognized the unique risks to which
farmers and ranchers are exposed.
Current agricultural tax provisions, on the income side, include
the following:
Installment Method
The installment method allows income to be recognized for tax
purposes when payment is received, rather than when the sale is made.
Non-farm businesses are not allowed to report income from the sale of
products manufactured or held for sale to customers using the
installment method. Farmers and ranchers may use the installment method
to report the sales of raised crops and livestock and recognize taxable
income when payment is received.
Farmers and ranchers may choose not to use the installment method
to ``smooth'' taxable income. Smoothing income is a term I use to
describe tax planning which reduces reporting taxable income in high
tax brackets in 1 year, and losing tax deductions in other years from
having too low of income.
Farmers may choose to sell product in 1 year and contract to
receive payment in a subsequent year. These deferred payment contracts
add flexibility to the timing of income. In this manner, a farmer may
sell or commit to sell product when she believes the market provides
the best price, and not be as concerned as to the tax ramifications of
having sold two crops in 1 tax year. By using the deferred payment
contract, the 2015 crop may be sold and sales price collected in 2015,
also selling the 2016 crop in 2016, but arranging for payment in 2017.
Commodity Credit Corporation (CCC)
The CCC provides loans to farmers on a non-recourse basis. That is,
the farmer may borrow from the CCC and, if the collateralized crops
decrease in value, the farmer may forfeit the crop to the government.
If the price for the crop is lower than the target price, the farmer
may keep the loan proceeds by transferring the crop to the United
States. The farmer is not required to repay the balance of the loan.
The result of the CCC loan is to set a floor on the price of the crop.
The taxation of CCC loans is flexible. A farmer may choose to
report loan receipts as taxable income in the year received, or treat
the loans as true loans. If treated as taxable income, the repayment of
the loan will provide a deduction when the crop is sold. Alternatively,
if the CCC loan is treated as a true loan, the repayment of the
principal does not provide a tax deduction. If the CCC loan, treated as
a true loan, is forfeited (to the United States), income is recognized
for tax purposes at that time.
Crop Insurance
Farmer and ranchers need flexible tax provisions to help account
for the risks of unpredictable weather and uncontrollable markets. Crop
insurance proceeds may be deferred. Many farmers recognize taxable
income from a crop in the year after harvest. When a crop failure
occurs, crop insurance may be received in the year of harvest. If this
happens for the farmer whose normal marketing is to recognize taxable
income in the subsequent year, more than one year's crop is taxable in
1 year.
To avoid a spike in income from receiving 2 years of income in 1
year, farmers can defer the recognition of crop insurance income to the
subsequent year. If the farmer receives crop insurance on more than one
crop, an election for one crop is an election for all crop insurance
proceeds received in that year. The farmer does not have a choice as to
the amount of crop insurance to defer. The election is ``all or
nothing.''
Livestock Sales, Weather, and Disease
Livestock sales are likewise provided various deferral
opportunities for weather and disease.
A 1 year deferral of income is available for sales of excess
livestock to the extent the sale is due to drought, flood, or other
weather-related conditions. The area must be designated as eligible for
assistance by the United States.
Livestock available for deferral may be either raised or purchased
animals, and may be held either for resale (inventory livestock) or for
productive use (depreciable livestock, such as dairy, breeding, draft,
or animals held for sporting purposes).
Also, a 2 year deferral is available for livestock destroyed by
disease, if the livestock are replaced within that 2 year period.
The replacement period is 4 years for draft, breeding, or dairy
livestock sold early on account of drought, flood, or other weather-
related conditions. The IRS has authority on a regional basis to extend
the replacement period if the weather-related conditions continue.
Basis Upon Death
A ``fresh start'' applies to re-set the tax basis of assets upon
the death of the taxpayer. Heirs receiving property need not search for
sometimes unavailable records to determine the decedent's basis in
property. As such, depreciable assets will generate depreciation
deductions for the heirs who continue to operate the farm or ranch.
Inventory on hand at death is also provided a basis step-up,
particularly important for the farm because raised inventory has a zero
tax basis.
Hedging Opportunities
Farmers may reduce price risk for both the sale of crops and
livestock and for the purchase of inputs. Puts, calls, and the
commodity futures markets are available to hedge prices for the inputs
and sales. The hedging opportunities provide ordinary income or loss
treatment upon using techniques to lock-in prices. Without this
provision, a loss on a commodity futures contract would be capital
gain, the deductibility of which is limited to capital gains plus
$3,000.
Farmers using the commodity futures market forgo capital gains on
these contracts because of the use of the contracts in hedging
transactions, but this protects the availability of the ordinary loss
deductions.
Tax-Deferred Exchanges (Section 1031)
Like-kind exchanges are an important tax provision for farmers and
ranchers. Land is very expensive. Quality neighboring land may become
available for purchase only upon a generational change. The ability to
exchange, tax-free, less desirable land (perhaps land many miles or
counties away) for land closer to the home base of operations, should
not be a taxable event. The farmer has not cashed-out her investment.
Capital gain taxes should not have to be paid because she has fully
reinvested the proceeds in like-kind replacement property.
Cancellation of Debt Income
The default treatment for the discharge of indebtedness is as
taxable income. However, exclusions are available if the taxpayer is in
bankruptcy or insolvent. A specific provision is available for the
discharge of qualified farm indebtedness. This provision applies to
qualified farmers who continue to own trade or business assets or who
have sufficient tax attributions (tax loss and credit carryovers). The
exclusion acts as a deferral mechanism, in that the farmer isn't forced
to recognize income today, but instead reduces future deductions and
credits.
* * * * *
On the expenditure side of the ledger, farmers use accounting
method and depreciation provisions to help manage the tax liability.
Section 179
Section 179 allows farmers to expense up to $510,000 (now indexed
for inflation) of the cost of equipment and other tangible assets used
in production. This provides a deduction in the year of purchase,
rather than depreciating the assets over several future years. Section
179 simplifies the computation of depreciation, while providing
flexibility to the farmer in choosing how much Section 179 deduction to
claim.
Bonus Depreciation
The farmer or rancher may choose to expense 50 percent of the cost
of original use assets purchased for use on the farm. If bonus
depreciation is claimed, future depreciation deductions are reduced.
This is a timing issue. This is not available for used assets.
The farmer may elect not to claim bonus depreciation on a class-by-
class basis. The farmer may not, however, choose a lesser percentage.
In this respect, Section 179 is much more flexible.
Bonus depreciation may be claimed on most assets used on a farm,
since bonus depreciation is available for assets with a cost recovery
period of no greater than 20 years. Farm buildings qualify for bonus
depreciation, as they have a cost recovery period of 20 years.
Under The Protecting Americans from Tax Hikes (PATH) Act enacted
December 2015, bonus depreciation is available for the cost of plants
or grafting for new orchards, vineyards, and other nut or fruit bearing
plants. Additional bonus depreciation is not available, however, when
the orchard or vineyard is placed in service (and depreciation
deductions begin).
Bonus depreciation is scheduled to be reduced to 40 percent for
2018 and 30 percent for 2019, after which the provision expires.
Raising Livestock
Farmers may deduct the costs of raising livestock, even though
dairy cattle, for example, otherwise have a pre-productive period of
more than 2 years. Consequently, when cattle are culled from the
breeding or dairy herd, the farmer recognizes Section 1231 gain,
usually taxed as capital gain.
Raising Crops
Farmers may deduct the costs of raising crops, except for those
crops, such as vineyards and orchards, which have a pre-productive
period of more than 2 years. An election is available to deduct the
costs of establishing the vineyard or orchard. If this is elected,
depreciation on all farm assets must be computed using slower methods
over longer cost recovery periods.
The cost of raising the crops is deductible in the year paid for
the cash method farmer. Since all costs have been deducted, the entire
sales price is taxable income when sold and the sales proceeds are
received.
Domestic Production Activities Deduction (DPAD) or Section 199
The Domestic Production Activities Deduction reduces the overall
tax rate from growing and production activities. This is only
available, however, if the farmer has employees to whom wages are paid.
Consequently, the sole proprietor with no employees does not receive
the benefit of this deduction, except in the case of receiving an
allocation of the deduction from a cooperative to which the farmer
transferred his crops.
DPAD provides a deduction of nine percent of the net farm income,
effectively lowering the tax rate. DPAD is not allowed, however, to
reduce self-employment income on which self-employment tax is paid.
Soil and Water Conservation Expenditures
Expenditures under government programs for soil and water
conservation may be deducted in the year paid, limited to 25% of gross
income from farming. These include the treatment or movement of earth,
such as leveling, conditioning, grading, terracing and contour
furrowing. They also include the construction, control and protection
of diversion channels, drainage ditches, irrigation ditches, earthen
dams, water courses, outlets, and ponds. The eradication of brush and
the planting of windbreaks are also includes in the Section 175
expenditures. These expenditures must be consistent with a plan
approved by the Natural Resources Conservation Service (NRCS) of the
USDA. If no NRCS plan exists, the expenses must be in conformity with
the plan of an applicable state or local agency, comparable to an NRCS
plan.
The deduction for improvements is not available if the land was not
previously used in farming. Also, land clearing expenditures which
prepare the land for farming must be added to the tax basis of the
land. Landlords who receive a share rental or a cash rent based on farm
production are considered engaged in farming, and are allowed to claim
the Section 175 soil and water conservation expenditures deduction.
The amounts are subject to recapture as taxable income if the
farmland is disposed within 10 years of its acquisition, based upon a
sliding scale.
Fertilizer and Soil Conditioning Expenditures
Although fertilizer and soil conditioning expenses benefit the soil
over several years, a farmer may deduct the fertilizer in the year
purchased. This is important for farmer, in that if the amounts are not
deducted in the year purchased, the expenses must be claimed over the
period in which the inputs benefit the soil. An agronomist would have
to be hired to determine the proper period of time over which the
deductions would be available.
Interest Expense
Farming is capital intensive so interest expense deductions are
important. Farm land purchases do not generate depreciation deductions.
The land must be paid for after income taxes are paid. To illustrate:
In order to make payment of principal on debt incurred to purchase
land, a farmer in the 45 percent tax bracket (25 percent income tax
plus 15 percent self-employment tax, plus five percent state income
tax) must generate $182 of income in order to have after-tax cash $100.
In the early years of paying principal and interest on the mortgage,
most of the payment is interest expense. The beginning farmer doesn't
have the sufficient capital to generate the return on investment
necessary to expand; the interest expense deduction to acquire the land
is necessary to assure the economy of scale that could cover overhead
expenses.
Farm Supplies
Farmers may deduct farm supplies in the year paid, rather than the
year consumed (within limits). If certain inputs are scarce, buying
early can ensure they have the chemicals, fertilizers, seeds and other
supplies when they are needed.
Rent Expense
Similarly, farmers (similar to other businesses) may prepay rent,
as long as the rental period expires by the end of the following year.
Landlords may insist on payment in advance; the farmer may deduct this
payment.
Health Insurance
As with other self-employed taxpayers, farm sole proprietors,
partners, and S corporation shareholders may deduct health insurance
premiums (subject to sufficient farm income).
Charitable Donation of Conservation Easement
Farmers also benefit from an enhanced limitation for the donation
of a conservation easement. Rather than a 50 percent of adjusted gross
limitation for non-farm taxpayers, a farmer or rancher may claim a
charitable deduction up to 100 percent of adjusted gross income. If the
charitable deduction is greater than the limitation, the excess
charitable deduction may be carried forward for up to 15 years.
Charitable Contribution of Food
Farmers may deduct up to 50 percent of the value of apparently
wholesome food given for the benefit of the needy. This is a new
provision added as a result of the 2015 PATH Act. It provides the same
incentive to grower/packer/shippers who own cash basis inventory, as
provided to the local grocery store that has excess food inventory
nearing its expiration date.
This is a deduction particularly suited to community supported
agriculture (CSA) producers and the local farmers markets.
* * * * *
Negative Tax Provisions for Farmers
The uniform capitalization rules on pre-productive expenses hurt
orchardists and viticulturists. They are not able to currently deduct
the costs of establishing the expensive orchards and vineyards to
supply the nation with apples, oranges, grapes, and other fruits and
nuts. Instead they must capitalize these costs to deduct the investment
only when the orchard or vineyard becomes productive, and then over a
10 year period.
In addition, farmers and ranchers are also not allowed to use the
faster depreciation methods that are available to non-farmers.
* * * * *
The unique business of farming also benefits from several distinct
tax computation provisions.
Estimated Tax
Form 1040 farmers need not pay estimated taxes if the tax return is
filed by March 1. Farmers who don't file by March 1 can pay one
estimated tax payment on January 15. The payment of at least 100
percent of the prior year's tax or \2/3\ of the current year's tax on
January 15 allows the filing of the Form 1040 by April 15 without
underestimation penalties. This flexibility helps farmers by not having
to pay income tax on expected income that doesn't arise to the risks
mentioned above.
Farm Income Averaging
Farm income averaging allows farmers an imperfect method of
reducing the effect of income spikes. Farm prices fluctuate greatly and
sometimes the farmer can't use the other methods to arrange for the
best timing for the recognition of income and payment of expenses.
Sometimes 2 (or more) years of crop income is recognized in 1 year,
pushing the farmer into higher than normal tax brackets.
Farm income averaging may be particularly beneficial when the
farmer retires, in that the cash method farmer likely has few farm
expenses in the final year, but may have 2 or more years of crop
income. The spike in income would otherwise cause the farmer to pay
income tax at higher than normal marginal tax rates.
Net Operating Losses
Farmers have the option of using a net operating loss carryback
period of 5 years, rather than the 2 year provision applicable to non-
farmers.
The net operating loss carryback rules are inflexible, however, in
that the taxpayer cannot choose how much loss to apply in any 1 year.
The loss must be carried back to the earliest year in the allowed
carryback period, to offset all of the income in that earliest year
before applying loss to the next earlier year.
Capital Gains
Farmers benefit from capital gains, often from the sale of long-
held capital assets such as land and buildings. The capital gain is
often illusory, however, in that inflation accounts for the higher
sales price, especially for assets held since the 1970s and 1980s when
annual inflation approached 13.5 percent.
Optional Self-Employment Tax
Farmers benefit from the optional self-employment tax, to earn
credits toward the Social Security system even though suffering a loss
in a current year. Non-farm taxpayers may elect optional self-
employment tax for only 5 years. Farmers do not have a limit. In
addition to earning credits toward the Social Security system, the
optional self-employment tax computation might allow the taxpayer to
qualify for the earned income tax credit.
Finally, I thank the House Agriculture Committee for its efforts
during this last year. Various agricultural subsidy programs rely on
the calculation of Adjusted Gross Income. This term doesn't translate
well for farms which operate as corporations or other limited liability
entities. Previous to the Committee's involvement, the USDA's handbook
did not allow the up-to-$500,000 deduction for Section 179 expenses to
reduce the income of the operation.
For example, a multi-member LLC with $600,000 of income (well under
the $900,000 limit for an individual farmer) was forced to report its
income as $1.1 million, preventing the individual members from
qualifying for the agricultural programs to which they would have been
entitled had they farmed separately. The staff's involvement fixed an
error in the guidance.
Thank you for your time, and I look forward to addressing your
questions.
The Chairman. Thank you, Chris.
Guido, 5 minutes.
STATEMENT OF GUIDO van der HOEVEN, EXTENSION
SPECIALIST/SENIOR LECTURER, DEPARTMENT OF
AGRICULTURAL AND RESOURCE ECONOMICS, NORTH
CAROLINA STATE UNIVERSITY, RALEIGH, NC
Mr. van der Hoeven. Good morning, Chairman Conaway, Ranking
Member Peterson, and Committee Members. Thank you for the
invitation to testify today.
I am Guido van der Hoeven, an Extension Specialist and
Senior Lecturer at North Carolina State University, with
responsibilities in farm management and taxation. Additionally,
I serve as President of the Land-Grant University Tax Education
Foundation, and I am co-chair of the National Farm Income Tax
Extension Committee which meets annually with IRS at its
national office.
Today, I want to speak about the farm transition during the
lifetime of a retiring farmer, and the tax impediments that
exist.
These tax barriers often impact the beginning farmer as
well in the form of higher down payments when purchasing a farm
and improvements. Production agriculture is, and has
historically been, a capital-intensive business, as others have
testified. The acquisition of land, equipment, and livestock is
a daunting challenge to a new generation of farmers. A barrier
to transferring farm assets during an exiting farmer's lifetime
is the increased income tax liability resulting from a farm
sale when compared to transfers at the retiring farmer's death.
Currently, if a retiring farmer sells assets to a beginning
farmer, he or she must recognize and pay income tax on the gain
from that sale. If the retiring farmer gives the assets to the
beginning farmer, the beginning farmer receives a carryover
income tax basis in these assets, and must recognize and pay
tax on the donor's unrealized gain upon a subsequent sale. By
contrast, if the retiring farmer holds onto the assets until he
or she dies, their income tax basis in the assets is adjusted
to the date of death value, and no one has to recognize and pay
income tax on the difference between the retiring farmer's
basis and the date of death fair market value of these assets.
Agriculture is unique in that its largest asset, land, is
an asset that typically appreciates in value, resulting in
large capital gains upon sale. Likewise, raised livestock have
built-in gains with increase in numbers and value per head over
time. Depreciated operating assets such as purchased livestock,
tractors, and machinery have little to no income tax basis, as
the exiting generation begins to consider retiring from the
business of farming.
My written testimony discusses tax reform proposals
creating tax incentives that may encourage retiring farmers to
transfer farm assets during their lifetimes, rather than
waiting to transfer them at death.
Allow me to tell you a story. Since mid-March, I have
visited two farm families, representative of North Carolina's
production agriculture, in the process of retiring from active
farming. The task at hand is to find a way to move forward and
to fund their retirement years. Farmer one is 70 years old and
has no family successor, but he has identified a young farmer
in the area. Initially, the plan was to sell 2016's crop and
machinery line in 2017. Doing so results in $1.2 million of
income, and an approximate $490,000 tax bill. Farmer one may
now delay as he feels he can't afford to retire. Farmer one is
considering 5 more years of farming to manage and reduce his
tax bill upon retirement. Farmer two is 68 years old. He farms
with two sons, using multiple entities which are part of his
and his sons' estate and succession plans. While accomplishing
the goals of estate planning, transition of management, as well
as operating assets, the family has incurred great expense to
create and operate these entities, in part to manage a tax
bill. Both farmers have engaged in allowed tax deferral over a
lifetime of farming. Now, a large tax bill is a barrier to
exit, and preventing the younger generation to fully grasp the
throttle of the farm business. The ultimate goal of my tax
reform proposals, which is supported by the two farm family
stories just told, is to provide incentives to allow for
lifetime transfer of farmland and production assets to
beginning farmers to continue working the land. Then the
retiring farmer has the ability to generate a retirement income
stream with a manageable income tax liability. The beginning
farmer's financial requirements may be reduced when making the
purchase. In the end, one might say it boils down to cash-flow
problems for the farmers wanting to retire.
This concludes my oral statement. I am available for
questions. Thank you.
[The prepared statement of Mr. van der Hoeven follows:]
Prepared Statement of Guido van der Hoeven, Extension Specialist/Senior
Lecturer, Department of Agricultural and Resource Economics, North
Carolina State University, Raleigh, NC
Overview
Production agriculture is and has historically been a capital
intensive business. The acquisition of land, equipment and livestock is
a daunting challenge to a new generation of farmers. An impediment to
transferring farm assets during an exiting farmer's lifetime is the
increased income tax liability resulting from lifetime transfers of
those assets compared to transfers after the exiting farmer's death. If
an exiting farmer sells assets to a beginning fa[r]mer, he or she must
recognize and pay income tax on the gain from that sale. If the exiting
farmer gives the assets to the beginning farmer, the beginning farmers
receives a carryover income tax basis in the assets and must recognize
and pay tax on the donor's unrealized gain upon a subsequent sale. By
contrast, if the exiting farmer holds on to the assets until he or she
dies, the heir's income tax basis in the assets are adjusted to the
date-of-death value of the assets and no one has to recognize and pay
income tax on the difference between the exiting farmer's basis and the
date-of-death fair market value of the assets.
Agriculture is unique in that its largest asset, land, is an asset
that typically appreciates in value resulting in a large capital gain
upon sale. Likewise raised livestock have built-in gains from the
increase in numbers and value per head over time. Depreciated operating
assets such as purchased livestock, tractors, and machinery have little
to no income tax basis as the exiting generation begins to consider
retiring from the business of farming. The current tax rules encourage
farmers to hold on to these assets until they die so that the income
tax basis in the assets adjusts to the date-of-death value and no one
is required to recognize and pay income tax on the gain. The following
proposals change the tax incentives for exiting farmers to encourage
them to transfer farm assets during their lifetimes rather than waiting
to transfer them at their death.
Proposed Tax Law Reforms To Facilitate Transition of Farm Assets
(1) Proposal To Create an Incentive To Sell Farming Assets Before Death
Under this proposal exiting farmers are allowed to put part or all
of the proceeds from selling farm assets into a tax deferred ``farm
retirement account'' (FRA). The gain on sale proceeds that are placed
in the FRA are not taxed until they are withdrawn. At the time of the
farm sale, the capital and ordinary gains on the proceeds placed in the
FRA would be calculated but not recognized. As money is withdrawn from
the FRA, the capital and ordinary gain from the farm sale and the
income earned by the account would be recognized. The owner and
beneficiaries of the FRA could be required to withdraw minimum
distributions similar to current retirement accounts.
The FRA provides an income stream for the retired farmer and defers
income taxes on the gain from the sale of farm assets until the exiting
farmer receives sale proceeds as a FRA distribution. Ultimately, the
retirement account is consumed and the income tax paid by either the
retired farmer or beneficiaries.
A proposed alternative to the one described above is to allow
``super funding'' of an IRA through a farm sale. Under this proposal,
the retiring farmer may sell a farm at fair market value, however
recognize the tax consequence of the farm's sale based on the special
use value under I.R.C. 2032A rules. The exiting farmer can use the
difference between the fair market sale price and the section 2032A
special use value to ``super fund'' an IRA. The retiring farmer would
withdraw distributions from this IRA under the distribution rules
currently in place for IRAs. Again, this provides an incentive to
transition land to beginning farmers while allowing a portion of the
tax consequence of the sale to be paid over a period of time while at
the same time the retired farmer has income to provide for his/her
needs.
(2) Proposals Regarding Installment sales
Under current Federal income tax law, a retiring farmer can report
the gain from selling farming assets as he or she receives installment
payments for them. However, the seller must recognize all the
depreciation recapture from the installment sale of assets in the year
of the sale.
If the seller dies before the end of the installment contract, the
gain from the installment sale that was not recognized by the seller
before death must be recognized by the seller's estate or heirs when
the remaining contract balance is paid or forgiven. By contrast, if the
seller had retained ownership of the farming assets until death, the
income tax basis in the assets would be adjusted to their date-of-death
value and no one would recognize and pay income tax on the difference
between the seller's basis in the assets and the value of the assets on
the date of death.
Tax Reform might amend the installment sales rules to encourage
sales of farm assets before death. Installment sales provide the dual
advantage of providing retirement income to the exiting generation and
allowing the entering generation to use farm profits to make payments
for purchased farm assets.
Proposed changes are:
(a) Allow retiring farmers to use installment reporting for
depreciation recapture on the sale of assets that were used
in the farming business. This would allow the exiting
farmer to sell and receive installment payments for
machinery, purchased breeding, dairy or draft livestock,
and buildings without triggering an acceleration of
recognizing gain.
(b) Allow step-up in the basis of the installment contract for the
sale of these farm assets to the value of the contract on
the date of the selling farmer's death. This would allow
the exiting generation to make use of installment sales
without losing the full benefit of the tax-free step-up in
basis at death.
(3) Proposal for Tax Reporting of Lump-Sum Sales of Farms and Equipment
Some retiring farmers may not be able to take advantage of
installment reporting of their gain on sale of their farm because they
do not have the means to finance the buyer's purchase of their farm.
They would have a greater incentive to sell the farm to a beginning
farmer if the tax law allowed them to spread their gain from the sale
over the 5 tax years rather than recognizing all of it in the year of a
lump-sum sale.
Under this proposal, 20% of the gain from a lump-sum sale of
farming assets to a beginning farmer would be reported in each of 5
years, beginning with the year of the sale. The gain would retain its
character as capital or ordinary.
(4) Proposal to retain Like-kind Exchange rules under I.R.C. 1031
If Congress makes changes to the like-kind exchange rules, they
should be retained for transfers of at least some farm real estate so
that the exiting generation can sell the buildings and some farm land
to the entering generation and roll the gain into replacement farmland
or other real estate. This gives the entering generation a base upon
which to build its own business without the risk that the exiting
generation will give or sell the farm to someone else upon death. If
necessary for political or other reasons, the provision could be
limited to sales under a certain limit such as $1 million or to family
members who must continue farming for a period of time such as 10 years
to avoid triggering recognition of the gain.
(5) Proposal for Self-Employment Tax on Rental Income
Under current law, exiting farmers who rent their farmland to
entering farmers and stay active in the farming business must pay self-
employment tax on their net rent. This makes it harder for exiting
farmers to transfer the use of their land to entering farmers by
renting it to them. By contrast, owners of other real property, such as
a warehouse used in a business, are not subject to self-employment tax
on the net rent they receive from the warehouse whether or not they
stay active in the business that rents the warehouse from them.
This disparity can be eliminated by removing the self-employment
tax on rent received by a landowner who materially participates in the
production of agricultural or horticultural commodities on his or her
land.
Discussion of Proposal for Self-Employment Tax on Rental Income
I.R.C. 1401(a) imposes a 12.4% tax on up to $127,200 (for 2017)
of self-employment income. This is alternatively referred to as the
``old age, survivor and disability insurance'' or as the ``[S]ocial
[S]ecurity'' tax.
I.R.C. 1401(b) imposes a 2.9% tax on all self-employment income.
This is alternatively referred to as the ``hospital insurance'' or the
``Medicare'' tax.
The combination of the above two taxes is 15.3% on the first
$127,200 of self-employment income in 2017 (this figure is indexed for
inflation and therefore increases each year by the increase in the
consumer price index.) and 2.9% on self-employment income above
$127,200 (in 2017). The combination of the two taxes is often referred
to as the ``self-employment'' tax. Note that the self-employment tax is
similar to the FICA tax that is imposed on an employee's wages. The
combination of the employee's (7.65%) and employer's (7.65%) shares of
the FICA tax equals the 15.3% self-employment tax.
I.R.C. 1402(b) defines ``self-employment income'' as ``net
earnings from self-employment'' with some exceptions that are not
important to this discussion.
I.R.C. 1401(a) defines ``net earnings from self-employment'' as
all income from a trade or business with several exceptions. The
exception of interest to this discussion is set out in I.R.C.
1402(a)(1). That exception excludes rent paid on real estate and on
personal property rented with the real estate. However, there are two
exceptions to the exception, one of which is for income derived by an
owner of land if:
a. there is an arrangement under which another person will produce
agricultural or horticultural commodities on the land and
the owner will materially participate in the production or
management of the production of the agricultural or
horticultural commodities, and
b. the owner actually materially participates in the production or
management of the production of the agricultural or
horticultural commodity.
The effect of this provision is a disparity in the self-employment
tax treatment of rent paid for farmland and rent paid for other real
property.
Example. Farmer Bill owns 400 acres of farmland that he rents
to his daughter under a cash lease that requires Bill to help
her make management decisions. After paying property taxes,
insurance and maintenance, Bill realizes $100,000 of net income
from the land each year. Under current law, Bill must pay
$15,300 ($100,000 15.3%) of self-employment taxes on that
income.
Contractor Kari owns a warehouse that she rents to her son
under a cash lease. After paying property taxes, insurance and
maintenance, Kari realizes $100,000 of net income from the
warehouse each year. Because the rent is not from land used in
farming, Kari does not have to pay self-employment tax on the
rent.
The proposed change in the law would eliminate the self-
employment tax on Bill's net rental income so that he and Kari
would be taxed the same.
This provision (the farmland exception to the real estate
exception) was added to the Internal Revenue Code in 1956. At that
time, farmers who were at the retirement age had paid into the [S]ocial
[S]ecurity system for only a short time and qualified for little or no
[S]ocial [S]ecurity benefits. The provision allowed them to build up
their [S]ocial [S]ecurity benefits after they quit farming by making
the rent they received subject to the self-employment tax and therefore
to be counted as [S]ocial [S]ecurity earnings. Most farmers who retire
today have built up [S]ocial [S]ecurity earnings that qualify them for
[S]ocial [S]ecurity benefits and there is no need for them to pay
[S]ocial [S]ecurity tax on their rental income after retiring from
farming.
The proposed amendment will solve the self-employment tax problem
not only for farmers who retire and want to participate in the
production on their land but also for farmers who rent their farmland
to their farming business entity. The IRS and the Tax Court think the
current law requires such landowners to pay self-employment tax on the
rent they receive from their business entity. See Mizell v.
Commissioner, T.C. Memo 1995-571; Letter Ruling 9637004; Bot v.
Commissioner, T.C. Memo 1999-256; Hennen v. Commissioner, T.C. Memo
1999-306; and McNamara v. Commissioner, T.C. Memo 1999-333.
In McNamara v. Commissioner, 236 F.3d 410 (8th Cir. 2000), the
Eighth Circuit Court of Appeals disagreed with the IRS and the Tax
Court and held that rent paid by the taxpayer's corporation to the
taxpayer for land owned outside the corporation is not subject to self-
employment tax if the rent is set at a fair rental rate. In Action on
Decision 2003-003, the IRS stated that it will follow the holding of
the McNamara case in the Eighth Circuit. However, the IRS did not
acquiesce to the Eighth Circuit's decision and will continue to
litigate its position in cases in other circuits. The proposed
amendment would eliminate the IRS argument that rent paid from an
entity for land held outside the entity is subject to self-employment
tax and therefore end the disparate treatment of taxpayers inside and
outside the Eighth Circuit.
(6) Proposal To Retain Step-Up in Basis to Fair Market Value at Death
If Congress repeals the Estate Tax it is proposed to keep the step-
up in basis rules found in I.R.C. 1014 similar to the rules of 2010
which allowed modified step-up on selected assets. This proposal would
help to ensure the ability to settle estates where certain assets might
be sold, with little to no tax consequence, to make equitable
distributions amongst heirs.
(7) Proposal To Enhance Section 529 Plans To Allow Beginning Farmers To
Invest in Farms
Under this proposal the Tax Code would be amended to allow
contributions to and withdrawals from a 529 account to be invested in
farm business capital as an alternative to investing in human capital
through higher education. The beneficiary (envisioned to be young
beginning farmer/rancher) as well as others can set aside funds in a
tax deferred account for the express purpose of purchasing a farm (or
business). Withdrawals used for disallowed purposes of the amended 529
account would follow current rules in place.
For this benefit some specific proposed rules:
(a) The beneficiary would not receive basis for the amount used in
the down payment which came from this proposed account. For
example: Joe Beginner used $100,000 from his special farm
down payment account to buy a farm priced at $300,000.
Joe's basis in the farm is $200,000 which is allocated in a
pro rata manner to land and improvements similar to I.R.C.
1060 rules.
([b]) If the beneficiary disposes of the property, except through a
like-kind exchange with the purpose to continue farming,
within a 10 year period from date of purchase, the tax
deferred savings of the down payment is recaptured in full,
similar to I.R.C. 2032A rules for estate special use
valuation.
(8) Replace the Income, FICA, and SECA Taxes with the FAIR Tax
The FAIR tax (H.R. 25/S. 18) would remove all the tax impediments
to farm transition.
Conclusion
In conclusion, many exiting farm operators want to see the business
that they have worked to create be kept together and passed to a new
generation of farm operators. Current law impacts this transfer and
often creates impediments to both parties and therefore these transfers
do not occur. Tax reform can facilitate transfers prior to death of the
exiting farmer.
The Chairman. Thank you, Guido.
Jim, 5 minutes.
STATEMENT OF JAMES M. WILLIAMSON, Ph.D., ECONOMIST, ECONOMIC
RESEARCH SERVICE, U.S. DEPARTMENT OF
AGRICULTURE, WASHINGTON, D.C.
Dr. Williamson. Chairman Conaway, and Members of the
Committee, my name is James Williamson and I am an Economist
from the USDA's Economic Research Service. I appreciate this
opportunity to present information on tax policy in the farm
sector.
This morning, I will discuss how three unique aspects of
agriculture; the legal structure, the capital intensity of
farming, and the volatile nature of farm earnings, are affected
by current provisions of tax policy. The analysis focuses on
family farms, which in 2015 accounted for 99 percent of all
farms, and this analysis uses the USDA's Agricultural Resource
Management Survey data.
To start, Federal tax policy has the potential to affect
the economic behavior and well-being of farm households, and
the impacts depend on their legal structure. The vast majority
of farms, as has been discussed, are organized as pass-through
entities that are not subject to income taxes themselves;
rather, the owners of the entities are taxed individually on
the share of income. Income received from farming and ranching
is passed through from the farm business to the individual
farmers when the farm is structured as a sole proprietorship,
to partners when the farm is structured as a partnership, or to
shareholders when the farm is structured as an S corporation.
In 2015, farms organized as these pass-throughs constituted 97
percent of family farms, and accounted for 85 percent of the
total value of agricultural production in the United States.
The more than two million family farm households earn
income not only from farming, but from a diverse array of
activities and endeavors, including off-farm work and non-farm
business interests. And because family farms are organized as
pass-throughs for the most part, when they have farm losses,
these losses are able to be passed through and offset non-farm
income, thus lowering their tax liability.
Farm businesses that are pass-throughs are impacted by the
individual income tax rates, as well as targeted business tax
provisions as provided by deductions, deferrals, and other
provisions.
I would now like to talk about some main tax provisions
that may affect family farms operating in a capital-intensive
industry. In particular, capital gains treatment and
depreciation and expensing of investment costs.
First, the tax treatment of capital gains. The Federal
income tax system taxes gains on the sale of assets held for
investment or business purposes, and held for more than 1 year,
at rates lower than on other sources of income. Under current
law, many of the assets used in farming or ranching are
eligible for capital gains treatment. In terms of investment
cost recovery, farming requires a substantial investment in
physical capital; machinery, equipment, and other depreciable
property. The Internal Revenue Code provides the opportunity to
accelerate recovery of such investment costs through
depreciation and expensing under Section 179, and these
provisions may benefit family farm businesses that make capital
investments. Additional allowable depreciation and first-year
expensing shift forward the time period in which investment
costs are recovered, thus lowering the cost of capital.
For the majority of family farms, investment levels are
well below the $500,000 limit specified within Section 179. In
2015, the average annual investment was approximately $17,000
for a family farm. However, the average figure masks the
considerable variation in investment among different types of
farms, and investments generally increased with the size of the
farm. We estimate that about \1/4\ of the 5,000 very large
family farms, those with at least $5 million in sales, exceeded
the $500,000 limit in 2015.
And finally, a few words on tax policy and the volatility
of farm income. Under a progressive tax system, taxpayers whose
annual incomes fluctuate widely may pay higher total taxes over
a multiyear period than other taxpayers with similar yet more
stable income. Farm business income is more variable than other
types of income from other sources, such as wages and salaries.
Tax provisions that allow these liabilities to be spread over
multiple years are beneficial to the farm, and these include
income averaging, as has been discussed, and cash accounting
methods.
In summary, the Federal tax policy has the potential to
affect many facets of the farm business operation and the well-
being of farm households. And this is because income from farm
work and off-farm income are combined for tax purposes by the
vast majority of farms. The capital-intensive nature of farming
means that tax policy can alter the cost of capital, and may
affect investment decisions.
And finally, other tax provisions that mitigate the effects
of volatile income from farming also help, but the extent to
which this is the case depends on the farm's size and other
factors.
Mr. Chairman, this concludes my statement. I will be happy
to answer any questions that the Committee may have.
[The prepared statement of Dr. Williamson follows:]
Prepared Statement of James M. Williamson, Ph.D., Economist, Economic
Research Service, U.S. Department of Agriculture, Washington, D.C.
Chairman Conaway and Members of the Committee, my name is James
Williamson and I am an Economist at the USDA's Economic Research
Service. I appreciate this opportunity to present information on the
legal structure of U.S. farms as it relates to their taxation, to
provide background on the economic effects of taxation, and to discuss
both the individual and business provisions that are available to
farmers. My remarks are based on the most recent data available from
USDA's Economic Research Service (ERS) and National Agricultural
Statistics Service (NASS), and publicly available data from The
Internal Revenue Services' Statistics of Income.
The mission of ERS is to inform public and private decision-making
on economic and policy issues related to agriculture, food, the
environment, and rural development. Our efforts support the goals and
objectives of USDA by providing economic statistics pertaining to
agriculture.
This morning I will discuss the potential impacts of tax policy on
U.S. agriculture focusing on farm structure, farm household and farm
business income, and farm investment and management. The analysis is
based on data from family farms, which in 2015 accounted for 99 percent
of farms. A family farm is any farm where the majority of the business
is owned by the operator and individuals related to the operator. A
farm is defined as any place from which $1,000 or more of agricultural
products were produced and sold, or normally would have been sold,
during the year. I will also provide information on farms of difference
sizes, as defined by their gross cash farm income.
Federal tax policy affects the economic behavior and well-being of
farm households, as well as the management and profitability of farm
businesses. Tax rates and tax preferences for certain activities affect
the after-tax income of farm households, but they may also influence
economic decisions such as labor force participation and labor
allocation (hours worked on and off the farm), decisions about the
household's investment portfolio and the timing of income realization.
Farm businesses are impacted both by individual income tax rates and
preferences, as well as business tax preferences as provided by
deductions, credits, deferrals and other provisions. Those include
special provisions that allow farms to allocate net income or net
losses across years to help reduce tax liabilities from
characteristically volatile farm business earnings (income averaging);
deductions allowing farms an extra deduction for net domestic
production (Domestic Production Activities Deduction), thus potentially
affecting hiring decisions; and farm capital investments subject to
accelerated cost recovery provisions that effectively lower the cost of
capital (Expensing and additional depreciation).
The vast majority of farms are organized as pass-through entities
that are not subject to income tax themselves. Rather, the owners of
the entities are taxed individually on their share of income. Income
received from agricultural production activities, and in some cases
lease payments from rented land and farm program payments--is passed
through from the farm business to the individual farmers, partners, or
shareholders of S corporations. The net profit or loss from
agricultural production activities that is received by individuals,
partners, and S corporation shareholders is reported on Schedule F of
form 1040 (partners and S corporation shareholders profit or loss on
Schedule E). In 2015, based on USDA Agricultural Resource Management
Survey (ARMS) data, farms organized as sole proprietorships,
partnerships, and Subchapter S corporations constituted about 97
percent of farms (just over two million farms) and about 85 percent of
total agricultural production in the United States. According to the
Internal Revenue Service's Statistics of Income, there were just under
1.9 million individual Form 1040 returns with a Schedule F in 2015;
this represents about 1.3 percent of all individual tax filers. Thus,
the individual income tax is significantly more important than the
corporate income tax for understanding how taxes affect most farmers.
Farm households earn income not only from farming but from a
diverse array of activities and endeavors, including off-farm work
(wages and salaries), capital income (interest, rents and dividends),
retirement income, Social Security benefits, and non-farm business
interests. For most farms, non-farm income is combined on the owner's
(or owners') Form 1040 with the farm's net profit or loss recorded on
Schedule F or Schedule E. In 2015, we estimate the average farm
household total income at $119,880 (the median income was $76,735) with
off-farm sources accounting for 79.4 percent of total income.
Taxation of Capital Gains Income
The Federal income tax system has historically taxed gains on the
sale of assets held for investment or business purposes and for more
than 1 year at rates lower than on other sources of income. The current
tax rate on long-term capital gains is 15 percent for taxpayers who are
below the 39.6 percent income tax bracket, and 20 percent for those in
the 39.6 percent bracket (0 percent for taxpayers in the 10 or 15
percent income tax brackets; in addition, certain high-income taxpayers
are assessed a 3.8 percent surtax). These reduced rates are especially
significant for farmers because farmers are more likely to realize
capital gains than the average taxpayer. Under current law, many of the
assets used in farming or ranching are eligible for capital gains
treatment and the amount of capital gains is increased by the ability
to deduct certain costs. The Internal Revenue Code currently allows for
proceeds from the disposition of such business property to be treated
as a capital gain (or loss).
In 2015, USDA survey data suggests about 40 percent of all
family farms reported some capital gains or losses, both from
the sale of farm assets and non-farm assets while IRS data
indicates the average individual taxpayer is far less likely to
report a capital gain or loss (13.6 percent).
For farms with capital gains, the reported average was
$10,567. That amount represented 8.6 percent of total income
reported by farm households. The total amount of reported
capital gains was $8.7 billion.
Overall, a majority (51.5 percent) of the capital gain
income in the sector was reported by small family farms; small
farms (gross cash farm income less than $350,000) account for
nearly 90 percent of all farms. Total capital gains accounted
for an estimated 2.2 percent of total farm household income for
that group.
Thirty-eight percent of mid-sized farms (farm with between
$350,000 and $1 million of gross cash farm income) reported
capital gains or losses, accounting for 20 percent of all
capital gains reported by farms.
Although large farms ($1 million-$4,999,999 in gross cash
farm income) comprised less than three percent family farms,
they accounted for about 22 percent of all capital gains
reported by farmers and they reported average capital gains of
$32,418--84 percent of which come from the sale of farm assets,
with the remainder from sales of non-farm assets.
Half of all very large farms, those with at least $5 million
of gross cash farm income, reported capital gains income.
Farm Capital Investment Demand and Cost Recovery Provisions
Farming requires a substantial investment in physical capital--
machinery, equipment, and other depreciable property. Two provisions of
the Internal Revenue Code that provide the opportunity to accelerate
the recovery of such investment costs, Section 179 and Section 168(k),
may benefit farm businesses that make capital investments. Section 179
allows a taxpayer to recover the cost of the investment by deducting or
``expensing'' the equipment in the year of the purchase, within certain
limits. In addition to Section 179, Section 168(k) allows farmers to
take additional depreciation or so-called ``bonus depreciation'' in
order to accelerate the recovery of capital costs. Both of the
deductions reduce the net business income of the farm, effectively
reducing taxable income. The two provisions may be used in
coordination, which has meant that much of the capital purchases made
during the past decade were eligible to be completely deducted in the
first year.
Business deductions that allow the farm to recover the cost of an
investment may alter investment decisions by creating a wedge between
the purchase price of capital before taxes and the after-tax cost of
capital. Increases in allowable depreciation and first year investment
credits shift forward the time period in which investment in capital is
recovered. All else equal, the sooner the cost is recovered, the lower
the user cost of capital and the greater the value of the tax recovery
option. That increase in the value of the tax recovery option could
lead to increases in investment.
Over the last decade, the annual maximum amount of capital expenses
that a farmer could immediately deduct from their gross income under
Section 179 has increased from less than $25,000 in 2000 to $500,000 in
2014, where it remains today. Any unused portion of the Section 179
deduction may be carried over to the next year. Section 179 imposes a
spending cap on the total value of investments made by a taxpayer in a
year before the deduction begins to phase out. In 2016 this spending
cap was $2,010,000, and it is adjusted for inflation; above this amount
the expensing deduction is subject to a dollar for dollar phase-out,
and is fully phased out when the aggregate investment exceeds
$2,510,000. The additional (bonus) depreciation allowance, which was
introduced in 2001 at 30 percent of the investment cost, is currently
50 percent. The bonus depreciation provision does not place a limit on
qualified investments.
Investment levels are well below the limits specified within the
Section 179 provision for the over-whelming majority of farms. Average
annual investment of farms has steadily increased from nearly $13,000
in 2009 to a peak of $21,401 in annual capital investments in 2014. The
latest year of USDA ARMS survey data, 2015, shows a pronounced decrease
in average annual investment to approximately $17,000.
Average Farm Capital Investment, 2009-2015
Source: ERS' calculations from USDA Agricultural Resource
Management Survey/TOTAL 2009-2015. Dollar amounts are in
nominal terms for comparison to their respective yearly Section
179 expensing limits.
The average figures mask the considerable variation in investment
among different types of farms. Small family farms (farms such as
retirement, residential or lifestyle farms, and farms with low sales)
made annual capital investments of less than $10,000 on average, and
only about 42 percent of them made an investment at all in 2015. Mid-
sized and larger family farms were much more likely to have made a
capital investment as at least 74 percent of them made an investment
during the year. Large farms (gross cash farm sales of $1 million up to
$5 million) are responsible for nearly 30 percent of the value of
agricultural production and made annual capital investments of $129,430
on average while very large farms (gross cash farm sales of $5 million
or more) made an average investment of $466,733.
Larger Family Farms Are More Likely To Have Capital Expenditures in 2015
------------------------------------------------------------------------
Item Small Midsized Large Very Large
------------------------------------------------------------------------
Number of 1,846,954 126,331 53,268 5,747
family farms
Percent of 90.9 6.2 2.6 0.3
family farms
Percent of 27 25 29 19
value of
production
(%)
Capital
expenditures:
Mean nominal 9,145 57,866 129,430 466,733
capital
expenditure
($)
Percent with 41.5 74.8 79.5 84.8
a capital
expenditure
(%)
Percent with 0.04 0.53 3.49 23.9
expenditure
above the
Section 179
expensing
limit (%)
------------------------------------------------------------------------
Source: ERS' calculations from USDA Agricultural Resource Management
Survey 2015. Small farms are farms with less than $350,000 gross cash
income; mid-sized farms have gross cash income between $350,000 and $1
million; large farms have gross cash income between $1 million and $5
million; very large farms have gross cash income over $5 million.
Note: this table excludes approximately 27,000 non-family farms.
The percent of farms that made an annual investment exceeding the
limit was less than one percent during 2009-2015, but, just as in the
average annual capital investment figure, this is somewhat misleading.
For example, in 2015, almost \1/4\ of very large farms made an annual
investment that exceeded the Section 179 expensing limit, whereas
approximately 3.5 percent of large farms made investments exceeding the
expensing limit. Together, while only representing less than four
percent of all family farms, those farms account for nearly \1/2\ of
all agricultural production by family farms. Therefore, Section 179 has
the potential to influence investment behavior among the farms that are
producing a significant amount of the total dollar value of
agricultural production.
Evidence from recent changes to cost recovery provisions suggests
that deductions can have a positive effect on incremental investment.
In the case of Section 179, a 2016 study in the journal Agricultural
Finance Review found that for every $1,000 increase in the Section 179
expensing amount, farms that had been previously limited by the
expensing amount made an incremental capital investment of between $320
and $1,110. The study also showed that increasing the percentage
allowance of bonus depreciation, for the most part, did not have a
statistically significant effect on farm capital investment. This is
because the majority of farms make investments that are below the
Section 179 deduction limit, and therefore the additional expensing
capacity under bonus depreciation was not utilized. Taken together, the
evidence suggests that farm capital investment is sensitive to the cost
of capital, but at current levels of expensing and accelerated
depreciation, we could expect to see incremental investment only by
farms that make large capital purchases.
Domestic Production Activities
The American Jobs Creation Act of 2004 replaced the foreign sales
corporation/extraterritorial income provisions, which had allowed U.S.
exporters to exclude a portion of their foreign sales income from
taxation, with a ``domestic production activity'' deduction for U.S.
manufacturers, including farmers. Domestic production activities
include activities that involves the lease, rental, license, sale,
exchange, or other disposition of tangible personal property that was
manufactured, produced, grown, or extracted in whole or in significant
part within the United States. It is not limited to exported goods.
While very few farms directly benefited from the export provision, an
estimated seven percent of farms directly benefit from the new domestic
production activity deduction. The deduction is limited to the lesser
of nine percent of adjusted gross income from domestic production
activities income or, 50 percent of wages paid to produce such income.
While the wages-paid provision limits the applicability of the
deduction for many smaller farms that hire little or no labor, larger
farms do have significant labor expenses. In 2015, family farms had
nearly $27 billion in labor expenses. The average deduction for
eligible farm households--those with labor expenses and net income from
qualified production activity--was $5,662. Among farms, commercial farm
households are the primary beneficiaries since they are more likely to
report both positive farm income and wages paid to hired labor.
Self-Employed Health Insurance Deduction
The self-employed health insurance deduction was created in 1988 to
give small business owners, including many farmers, tax benefits
similar to those of employees who receive employer-sponsored health
insurance. This deduction is especially helpful for self-employed
individuals who must purchase health insurance on their own. Since
2003, farmers and other self-employed taxpayers have been allowed to
deduct 100 percent of the cost of providing health insurance for
themselves and their families as long as they are not eligible for any
employer-sponsored plan. The self-employed health insurance deduction
is limited to the amount of the taxpayer's income from self-employment,
thereby disqualifying the deduction for farmers with net farm losses.
About one out of five farmers are eligible to use the self-employed
health insurance deduction in any given year. In 2015, farmers' average
cost for health insurance premiums was an estimated $5,883.
Households of small farms are less likely to be eligible to claim
the deduction, primarily because higher proportions of those households
receive health insurance from a non-farm job or do not qualify for the
deduction due to reporting a farm loss. Households of mid-sized and
large farms are more likely than those of small farms to use the
deduction. Nearly one out of every two operators of mid-sized and
large/very large farms are eligible to claim the deduction.
Farm Income Volatility and Tax Provisions
Under a progressive tax rate system, taxpayers whose annual income
fluctuates widely may pay higher total taxes over a multiyear period
than other taxpayers with similar yet more stable income. Farm business
income is more variable than many other sources of income, such as
wages and salaries, and transfer payments. A 2017 ERS study titled Farm
Household Income Volatility: An Analysis Using Panel Data from a
National Survey indicates that for larger scale commercial farms, those
responsible for about 80 percent of the value of U.S. agricultural
output, the median change in total income between years was about eight
times larger than for non-farm households. The study also found that
farm income (including government payments) accounted for 79.6 percent
of the total income variation for the farm households studied, while
10.5 percent of income variation was from off-farm wage income and 9.9
percent of income variation was from other off-farm income.
Farmers are also allowed to use cash accounting, which recognizes
income and expenses when received or paid. Cash accounting can reduce
taxable income through prepaid business expenses or deferred farm
income, and, as discussed above, well-timed capital purchases can
reduce taxable income through depreciation deductions or capital
expensing. While those provisions are useful in reducing income
variability, they are limited by the ability of a farmer to defer sales
or accelerate expenditures.
Income Averaging
Income averaging can reduce the effect of a progressive tax rate
system on taxpayers with highly variable year-to-year income by
allowing them to smooth their tax burdens over time through tax
accounting methods that consider multiyear income. U.S. farmers have
been eligible for income averaging since 1998. Under the current income
averaging provision, a farmer can elect to shift a specified amount of
farm income, including gains on the sale of farm assets other than
land, to the preceding 3 years and to pay taxes at the rate applicable
to each year. Income that is shifted back is spread equally across the
3 years. If the marginal tax rate was lower during 1 or more of the
preceding years, a farmer may pay less tax than he or she would without
the option of income averaging. The provision, however, does not allow
income from previous years to be brought forward. Furthermore, although
the provision is designed to reduce the effect of farm income
variability, as long as some farm income is available to be shifted,
the source of income variability does not need to be farm income for
income averaging to be beneficial.
In 2004, an estimated 50,800 farmers--or about five percent of
farms--reduced their tax liability on average by $4,434 with income
averaging according to one published study (cite). The reduced
liability totaled $225.3 million and amounted to a 23-percent reduction
in Federal income taxes for those using the provision. A large share of
the total tax reduction was realized by farmers with adjusted gross
income over $1 million. These farmers reduced their liability by an
average of $264,000, for a total of $82.6 million. While more recent
data are not available, farm income trended higher between 2010 and
2013, so the income averaging provision is likely to be of equal or
greater benefit to farmers during that period.
To conclude, Federal tax policy has the potential to affect many
facets of the farm business operation and the well-being of the farm
household. By altering the cost of capital, tax policy may affect
investment decisions, while other provisions provide benefits linked to
the volatility of farm income, but the extent to which this is the case
depends on the farm's size and other factors.
Mr. Chairman, this concludes my statement. I will be happy to
answer any questions that the Committee may have.
The Chairman. Well, thank you, Jim. I thank the witnesses
for your succinct testimony. I think everybody came in right at
or under the mark.
The chair would remind Members they will be recognized for
questioning in order of seniority for Members who were here at
the start of the hearing. After that, Members will be
recognized in order of arrival. I appreciate Members'
understanding.
With that, I recognize myself for 5 minutes.
All of you mentioned some complicating factor, or factors
that complicate the preparation of a tax return and all those
kind of things, some which were original with the 1986 Act,
others in response to impacts that the 1986 Act had moving
forward. The tax compliance costs that farmers incur, whether
it is the annual compliance costs and/or the estate planning
costs, nobody mentioned that in terms of an impact for
simplification, can all of you speak briefly to do, in fact, we
need tax reform at this juncture? Is this Code, with all of its
complications and all of its factors, actually the best one to
go forward with, or should we, in fact, be launching this
effort to do tax reform in the agricultural arena?
So in the 4 minutes left, Ms. Wolff, do you want to start?
Ms. Wolff. I think that we have all established that
farming and ranching is a very volatile business with many
challenges that other industries don't have. When you layer on
top of that a very complicated, complex Tax Code, you make the
business of running a farm even harder.
We have a once-in-a-generation opportunity to rework our
Tax Code. Our Tax Code hasn't, funnily, been rewritten since
1986, and we have both Congress and an Administration who has
pledged to take this seriously. Farmers and ranchers very much
want to lower tax rates and to make the Code simpler. Yes, I
believe that there is a push among farmers and ranchers to move
forward on tax reform.
The Chairman. Mr. Claussen?
Mr. Claussen. Thank you, Mr. Chairman. I will keep my
comments brief to allow time for the other panelists to
respond.
I would echo the comments that Ms. Wolff made with regard
to income tax simplifications. As we think about American
farmers and ranchers, they are subject to weather variability,
price variability, growing condition issues, logistical issues,
and all of those take a toll on their operation.
If we are able to take tax law and move it into an area
that is simpler and easier for them to understand, as well as a
reduction of the overall costs, that puts them in a much better
position to be competitive on a global scale.
Mr. Hesse. Thank you. With regard to the variability of
agriculture, weather patterns, commodity prices, it is
important to recognize that there needs to be flexibility, and
with flexibility comes complexity. Part of the reason for tax
reform though would be to lower the top rate, flatten out the
rates so that when that variability occurs, and you have the
income spike or the reduction in the income, that you aren't
damaged from having some of your income taxed at a higher rate
in 1 year and lower rate in another year.
But I just recognize that we need the flexibility for
making various decisions in the Internal Revenue Code, and with
that flexibility comes the complexity.
The Chairman. Mr. van der Hoeven?
Mr. van der Hoeven. Thank you, Mr. Chairman. And just one
real comment is to make definitions consistent across the Code,
and I will use two examples just to illustrate. For the
purposes of being a farmer so that you are exempt from the
estimated tax penalty, you have to have \2/3\ of your gross
income from farming. That is the definition of being a farmer.
If you want to make a conservation easement donation to qualify
for 100 percent against AGI, you have to have 50 percent gross
income from farming. Let's get consistent definitions because
it is really confusing. That is just one little area, just as
an explanation.
The Chairman. Thank you.
Dr. Williamson?
Dr. Williamson. The ERS, as a Federal statistical agency,
doesn't have opinions on reform policies, per se, but I can
offer some context. As a tax researcher, I can tell you that
prices matter, and taxes affect prices. If you are looking at
it in terms of investment, investment costs, Section 179
definitely affects the cost of investment.
And I would also like to point out, as has been mentioned,
is the nature of earnings, which are very volatile, and a lot
of times out of the control of the farm because of the weather,
they are producing a commodity that is sold in a global market,
they don't have a lot of control over the price. And also in
these recent economic conditions in agriculture, the downturn,
as you have heard about, this creates a lot of liquidity issues
with the farm. So meeting those liquidity issues is an
important thing also.
The Chairman. All right, thank you.
Mr. Peterson, 5 minutes.
Mr. Peterson. Thank you, Mr. Chairman.
I see a number of you commented on the section 1031
exchange situation, and you have talked about volatility. Going
forward, one of the concerns farmers have is how they are going
to survive this situation, but the land prices are too high,
equipment prices are high, everything is high, and the
commodity prices are low. Well, what I was surprised about when
you had mentioned the section 1031 exchange is you say we need
to keep it. And I get pushback from farmers all the time about
the fact that we have expanded this section 1031 exchange, you
don't have to really have like-kind for like-kind anymore. You
can sell a shopping center and you can then take that money and
go buy farmland. This is driving up the price of land, I will
tell you, and the land is too expensive already, and it hasn't
come down like it should, for a number of different reasons. I
don't remember when this changed, it must have been 1986, but
when I first started practicing it actually was like-kind for
like-kind. You had farmland for farmland or you didn't qualify.
My question is, I would like to see us go back to like-
kind; farmland for farmland. And what do you think about that,
all of the members of the panel?
Ms. Wolff. The value of like-kind exchanges for farm and
ranch businesses is like-kind to like-kind. Farmers use like-
kind exchanges for their equipment, for livestock, and for
land. We have had our members debate about changes in the
definitions. We don't have an official policy on that, but the
value of the provision for farm businesses is like-kind for
like-kind.
Mr. Peterson. No, I understand that, but what about
actually restricting it so it is like-kind for like-kind? That
is not what it is now. You can sell an asset in the Twin
Cities, an office building or whatever it is, take that capital
gain and come out and buy farmland and not pay tax. They are
paying more money than the farmer next door can pay for that
land because of the tax advantage. Why would anybody in
agriculture be opposed to keeping all that money out of our
business that is driving up land prices? That is my point.
Mr. Hesse. Well, Mr. Peterson, on the other side of that
too, the retiring farmer may want to go the other way in
selling the farmland and arranging the sale.
Mr. Peterson. Well, yes. No, I understand that. But the net
effect of it is, it is part of what keeps the land prices high.
Mr. Hesse. Certainly, since taxes are a part of cost of an
investment, the savings of tax is going to be built into the
capitalization of the land. I would encourage, with respect to
the equipment trades, that equipment trades where we have a
$510,000 Section 179 level, perhaps the exchange of equipment,
which also comes under Section 1031, is not as critical, but
certainly, with respect to real estate where the farmer is
looking to improve his position, selling off a lesser desirable
property in order to acquire property that is nearby or of a
higher quality, that, where there is not cashing out of the
investment, that is really what we are concerned about.
Mr. Peterson. Right, but that is not what the law does.
Anybody else have a comment?
Mr. Claussen. Yes, I would like to just make a comment as
it relates to section 1031 on land assets. Generally, when I am
having conversations with growers, with landowners, and they
are considering transitioning out of a piece of land, most of
the time they are looking at what are the net dollars in my
pocket, or what is the net effect to me. If there is, in fact,
going to be tax implications, absent a 1031 exchange, it may,
in fact, cause them to say, ``You know what, I don't know that
I want to sell that piece of ground, I don't want to get rid of
it, I will just hold onto it because I will be surrendering a
significant portion as it relates to income taxation.''
Mr. Hesse. For that reason, I may be willing to sell the
land for a slightly lesser price to the neighbor if I can
arrange a 1031 exchange and not pay tax, as opposed to having
to cash-out and pay tax.
Mr. Peterson. Well, yes, I agree with that, but in some
areas, we just see too much outside money coming in, and the
fact that we have kept base acres increases and that keeps the
land from coming down, and that is a big part of our problem.
We have a lot of things that are too expensive in agriculture,
but land is way out of control.
I yield back.
The Chairman. The gentleman yields.
Mr. King, 5 minutes.
Mr. King. Thank you, Mr. Chairman. I agree with the
gentleman from Minnesota on the section 1031 exchange comments.
I would like to direct my first question to our economist
on the panel, Dr. Williamson. And I want to ask you, rather
than the CPAs, this question. Who invented accrual accounting?
Who invented accrual accounting and what was the purpose?
Dr. Williamson. Mr. King, I do not know the answer to that.
Mr. King. Okay, I am going to take you at your word. And
then I would turn to one of our CPAs, perhaps Mr. van der
Hoeven.
Mr. van der Hoeven. I am not CPA.
Mr. King. I am sorry. Mr. Hesse. I can't see the----
Mr. Hesse. So the question regarding who invented accrual
accounting?
Mr. King. Yes.
Mr. Hesse. As an accounting profession, the accrual method
is a better matching of the expense relative to the income that
is earned. But taxation isn't an exercise in matching up or
reporting the true economic results of an operation. Tax
accounting is designed to raise tax money for funding the
country. Taxable income is determined as to however Congress
and the President decide that taxable income.
Mr. King. Thank you. Mr. Claussen, do you have a different
kind of an answer to that, or do you agree with Mr. Hesse?
Mr. Claussen. Well, I certainly would agree with Mr. Hesse
as it relates to the origins of accrual accounting, but I would
jokingly say sometimes it is referred to as cruel accounting as
well, in that there is a disconnect between the cash inflows
and the cash outflows of an operation, and the operation is, in
fact, trying to match up revenues when you have rights to those
revenues, and expenses when the obligation is created.
Mr. King. I would point out that my own observation on
having experienced this is that it is a lot easier to pay the
taxes when you actually have collected the money to pay the
taxes with. And so I certainly have sympathy with all of the
comments here that speak in favor of cash accounting for our
agriculture businesses, and that goes for the business that I
happen to start as well.
Also, the questions that I am hearing about interest
expense, and I know that everybody on the panel here agrees
that is an essential expense write-off, especially for our
young farmers and our beginning farmers, but I just wanted to
say a few words about that, and perhaps direct my question to
Ms. Wolff for a response. But as I look at it, I never imagined
that anybody would propose that you wouldn't be allowed to
deduct your interest expense, but for my neighbors that have
cash in the bank for crop inputs and everything they have is
paid for, what kind of an advantage they would have over a
beginning farmers. And I wonder if you would comment on that,
Ms. Wolff.
Ms. Wolff. An important thing to remember about agriculture
is that it is almost completely debt financed. Over 90 percent
of capital for farm business comes from loans. One important
point is that farmers don't have another way to raise money to
grow their businesses.
To your point about young farmers and ranchers, yes, losing
the interest deduction is even worse for them than an
established farmer because they have to borrow money to buy
land, to buy their equipment to get started. We believe that
the interest deduction should stay on the books because
agriculture needs it to secure the capital that they need, and
to make sure that our next generation of farmers can get
started.
Mr. King. And you can put on the books that I think it is a
harebrained idea to eliminate interest deduction, especially
for those reason, and especially because it is not a sound
business approach and it specifically disadvantages our entry
level farmers as well. Thank you, Ms. Wolff.
I would like to then turn to Dr. Williamson. The fair tax
was mentioned by the Chairman and the Ranking Member, and I
have long been a supporter of the fair tax. And can you think
of any good reason we shouldn't adopt such a tax policy?
Dr. Williamson. Could you remind me what the fair tax is?
Mr. King. It is a national sales tax on sales and service,
and there would be sales tax on business inputs, it would be
only on personal use. If you buy a combine, no sales tax, if
you buy a cap for your head, which usually farmers don't do,
you would pay the sales tax on that.
Dr. Williamson. Yes. Okay, again, at the ERS we do not have
an opinion on issues, for example, the fair tax. What I can do
is just provide you some background. Of course, as we have been
talking about, the industry is capital-intensive, there are
lots and lots of purchases of large machines, and again, the
income is highly volatile so there are years in which they have
losses and they need to do something with that, because they
also have income from off-farm work----
Mr. King. Thank you, Dr. Williamson. My clock ran out. I
appreciate your response.
I yield back.
The Chairman. The gentleman yields back.
Mr. Evans, 5 minutes.
Mr. Evans. Thank you, Mr. Chairman.
I would like to kind of follow up a little bit on what the
Chairman was raising earlier about the issue around the drive
to do tax reform, if I heard that question correctly. And
obviously, tax reform was done, as you indicated, about 1986,
almost 40 years ago, and obviously, the market has changed
completely, farming has changed completely. And I am trying to
understand, even though you answered that question, like the
drive to do tax reform, I am still trying to understand it in
the context of how the market has changed radically since 1986.
Farming is completely different from 1986 and where we are
today, I am just trying to understand in the very specific way,
because the title of this hearing is, Agriculture and Tax
Reform: Opportunities for Rural America. I am just trying to
get a little sense and do a little deeper dive to the question
that the Chairman asked you all. Yes, we will start with the
economist.
Dr. Williamson. Thank you, Mr. Evans. Compared to 1986, in
general in agriculture we have seen a consolidation of larger
farms now. They are farming more acres per farm. This requires
more equipment. The organization of farms has changed in terms
of legal structure, so we have seen more partnerships, more S
corporations forming. We have recently come off of several very
high years of farm income, and now farm income is down, so we
are seeing debt-to-asset ratios going up, so there is growing
need for liquidity. And again, as has been mentioned, they rely
heavily on debt, although that has probably been the case in
the past as well. So that is what I will say.
Mr. Evans. Yes.
Mr. van der Hoeven. I would concur, and I would just say
that when I started farming in 1984, corn was at $3.25 a
bushel. I sold my first crop at $1.40 and was happy to get it.
And we are now, in North Carolina, we are a basis positive
state, we are about $3.85 to $4.00, and these are in nominal
dollars. But a cotton picker is now $660,000 for one unit,
tractors are $200,000, so the inputs are huge, but the output
price, even though volume has gone up and we have had gains in
yields, but the margins are still very, very slow.
So to your point, some things don't change, but we slide
decimal points in places.
Mr. Evans. Yes.
Mr. Hesse. Thank you for your question, Mr. Evans. Part of
the issue goes back to the 1986 Act that brought a two rate
structure and broadened the base, and over the last 30 years we
have had various sectors of the economy, special tax
provisions, whether it be tax credits, carve-outs of special
deductions, or exclusions from income, which have added to the
complexity, and perhaps it is time to reset the Tax Code to get
back to that more flatter structure, and eliminate some of the
special tax incentives that had grown in the last 30 years.
Mr. Evans. Yes.
Mr. Claussen. Yes, I would like to make a comment as it
relates to farming operations from 30 years ago. There is a
tremendous amount of sophistication in farm operations. There
has been a significant amount of technological advances,
whether that is on the seed genetic side, whether that is with
cropping practices, whether it is sustainable practices, and
then also on the equipment side. All of that technology and all
that sophistication has continued to drive up the cost of doing
farming, which has indirectly forced farmers to continue to get
larger so that they can spread those fixed costs over more
acres. That is a significant difference from farming of 30
years ago.
Ms. Wolff. While my fellow panelists have pointed out many
things that have changed, I would like to point out that many
things remain the same, and that is that farmers still work on
tight profit margins, they operate in a world of huge risk and
volatility, and that they are price takers. As we move into tax
reform, we need to know that things have changed, but some
things are the same.
Mr. Evans. Real quick, Mr. Chairman. Can I give the
economists about 30 seconds?
The Chairman. Quickly.
Mr. Evans. Any model that you know around the world that
gives us a sense about a tax reform package that deals with
agriculture, any example you can point out?
Dr. Williamson. You mean model?
Mr. Evans. Any model, any country, any----
Dr. Williamson. I am not aware of other models outside the
U.S. as a model for reform for agriculture.
Mr. Evans. Okay.
Thank you, Mr. Chairman. I yield back.
The Chairman. The gentleman yields back.
Mr. Gibbs, 5 minutes.
Mr. Gibbs. Thank you, Mr. Chairman. Thank you for holding
this hearing. It brings to light some of the challenges we have
to get tax reform done right. And just a couple of thoughts
first before I ask my question.
As we know, agriculture is a highly cyclical business,
highly capital-intensive business, and this notion to do away
with interest deduction is ludicrous, and the notion to force
everybody to go to accrual versus cash accounting is ludicrous
because, first of all, it is going to make people borrow more
money to pay the taxes, from cash to accrual, and not have the
interest deduction. And then we heard from our first panel, Ms.
Kristi Noem, about the struggles her family went through and
the death tax and the impact, and it is important to remember
we have a generational change going on here. The average age of
farmers is about 60. And you can see how important this is to
be able to pass these family farms on, how the Tax Code can
impact that. I want to go on record that the interest
deduction, I can't understand why anybody came up with that
idea to do away with it as a legitimate deduction. Obviously,
they never ran a business. So that is my comment on that, I
would like to meet that person who came up with that idea.
But anyway, Ms. Wolff, one thing that has been mentioned
today that is being proposed in the tax reform is the border
adjustment tax, the BAT tax. What are you hearing from
producers, members around the country, thoughts about the
impact, positive or negative of that proposal? And then also, I
guess, I also hear about, well, other countries are doing that.
I don't know if you have the expertise in that, but maybe you
or other panel members could expound on that a little bit.
Ms. Wolff. Yes, first of all, I want to say that----
Mr. Gibbs. Your microphone.
Ms. Wolff. First of all, I want to say that American Farm
Bureau Federation has not taken a position on the border
adjustment tax, and that is because it has positives and
negatives. The concept of the tax is that income is taxed where
it is consumed, rather than where it is produced. When a
company sells a product overseas, that is not counted as income
for tax purposes, and when a company imports a product, they
cannot take that as a deduction. It changes the taxes of the
company that is importing or exporting.
On the export side, certainly, the provision is designed to
make our products more competitive in foreign markets. That is
a huge positive for agriculture because we export so much, 25
percent of our products. On the flipside, we also rely on
imported supplies; fertilizer, fuel, and that those items would
increase in price, at least initially. There are positives and
negatives. Different commodities have different percentages of
their sales overseas, rely differently on inputs. And so we
believe there are some positive things in it. We need to see
how it is actually structured, how it is actually written
before we can figure out whether it will be a net win for our
industry.
Mr. Gibbs. Any of the CPAs want to comment? Either one of
you.
Mr. Claussen. I will make my comments brief to allow time
for Mr. Hesse to comment.
Your question was what are we hearing about border
adjustment. We have had a number of listening sessions with
growers that we work with all across the Midwest and through
California, and many times we are getting more questions than
we have answers. And certainly, we are not in a position to
know the answers. We haven't seen a draft, we don't know all of
the implications of what it would look like, but one of the
challenging characteristics with regard to agriculture is the
fact that we are dealing with commodities. In many cases
grains, for example, are commingled from a variety of owners
and shipped overseas, so we know they are being exported, but
unfortunately, we are not able to identify which farmers have
the grain that is being exported.
Mr. Gibbs. Yes.
Mr. Claussen. Mr. Hesse.
Mr. Hesse. Yes, and I would just echo what Mr. Claussen
says. We really don't have the details to know how this might
work at the agriculture or the producer level, 25 percent of
our products are exported, it is not the producer usually that
is doing that direct exporting yet. It will be the costs coming
in, the inputs that will be built into the price, the cost
structure for the input for the farmer. Again, we don't have
enough details really to even know how it would be applying.
Mr. Gibbs. I think you are all right, it raises a lot of
questions about how the mechanics of it work and what the
consequences might be either way.
I yield back. Thank you.
The Chairman. The gentleman yields back.
Ms. Blunt Rochester, 5 minutes.
Ms. Blunt Rochester. Thank you, Mr. Chairman, and I thank
the panel.
Mr. Gibbs actually asked my question. I was really
interested in the border adjustment tax because you hear a lot
about it from the multinational perspective, you hear a lot
about it from the retail perspective, and I was really curious
about how it impacts agriculture, particularly with commodities
and trade. While you don't have a lot of the details, maybe you
could tell us what you think could be done to keep the
agriculture industry strong should a BAT tax be in place. And I
was going to start with Ms. Wolff, but I open it up to anyone.
Mr. Hesse. I really can't speculate on that, Ms. Rochester.
I just don't have, either the expertise, or the knowledge to
speculate on the economic consequences. I don't have any ideas
to provide to you.
Ms. Blunt Rochester. Okay.
Mr. Claussen. Congresswoman, I just have a few comments as
it relates to the current environment, and some of the tax
provisions that are currently in place that we see with regard
to exporting. There is a corporation that can be created that
is called an IC-DISC, and essentially what that is doing is
creating a tax advantage for the producer and exporter of those
goods. It is a difference between ordinary income tax rates and
dividend rates.
One of the significant challenges we have faced in
agriculture as it relates to implementing an IC-DISC is
strictly around this idea of whose products are being exported.
As Mr. Hesse indicated, we recognize the data is available,
that ag exports a significant amount of products, but it is
very difficult to identify whose products are actually being
exported.
We have made some inroads as it relates to the livestock
sector, specifically the beef sector, but on the grain side it
is almost impossible to know whose grains are being exported so
that they can utilize this.
So to your question, availability of information is very
difficult. The direct exporter obviously knows what is being
exported, but that information is not passed back through the
value chain as it relates to agriculture.
Ms. Blunt Rochester. Got you. Thank you.
Anyone else?
Mr. van der Hoeven. I would just make a comment that a few
years ago I was in Fort William, Scotland, and I was having
dinner and they were serving sweet potatoes. And so I asked
what was the source of sweet potatoes, because North Carolina
is pretty big on sweet potato production, and they came from
Vick Family Farms, and Mr. Vick was a student in our program.
And some of the sweet potato growers in North Carolina are very
active individually, doing the export market particularly
towards Europe. Again, it is a commodity that is very narrow,
very specialized and I just would bring that as just some
comment.
Ms. Blunt Rochester. Got you. Great, thanks.
Dr. Williamson. Ms. Blunt Rochester, I would like to add
just a few more things. Ms. Wolff laid it out beautifully the
complexity of this issue. Whether agriculture benefits depends
a lot on, as has been mentioned, the relationship to the
importers, statutorily we know who would pay the tax, or who
would benefit from a tax break, but in the end who is going to
benefit in terms of the incidence of the tax, it is going to be
based upon the relationship to the farmers or the cooperatives
and the exporter.
And on the other side, while I am not a trade economist,
but my colleagues tell me that trade relationships are dynamic,
and that is the cryptic way of economists saying, well, their
trade partners could raise their tax. And so there are many
moving parts to this puzzle.
Ms. Blunt Rochester. Great.
Dr. Williamson. Those are my comments.
Ms. Blunt Rochester. Thank you so much.
I was going to go on to my favorite topic which is market
volatility, but I don't think I have a lot of time, but I know
it is a big challenge. Dr. Williamson, you mentioned, and one
of my questions was about the smoothing out of it and whether
tax policy actually helps that. And you mentioned something
about depending on size and other factors, and I was just
curious what those other factors were.
Dr. Williamson. Okay, so thank you for the question. I was
speaking in terms of smoothing spikes in incomes. We have
certain years where, for example, 2012-2013 we had some very
good years in agriculture, now followed by depressed prices, so
we have a lot of losses and lower income.
So the changes would depend on the market they are in. For
example, grains, corn has been down, fruits and vegetables, has
maintained a pretty steady revenue. I was speaking in terms of
production commodity production and variation and commodity
production. Milk, for example, might be off from grains, or
fruits and vegetables productions.
Ms. Blunt Rochester. Thank you.
I yield back my time.
The Chairman. The gentlelady yields back.
Mr. Crawford, 5 minutes.
Mr. Crawford. Thank you, Mr. Chairman.
Ms. Blunt Rochester brought up a good point about
volatility, and I want to kind of carry on that conversation
just a little bit.
Since we have so many accountants in the room, maybe I will
get an answer to this. Is the premium on a put option tax
deductible?
Mr. Claussen. There are a number of ways that you can
handle hedging and risk management accounting. Generally, on a
put option, because it is an option, when you receive that cash
it is going to be taxable to you, and if you pay that cash then
it is going to be a deduction for you.
Mr. Crawford. The premium on the put option would then be
tax deductible, and if you exercise the option and receive
cash, at that point it is taxable.
Mr. Claussen. Right. Once it is no longer an open position
and goes to a closed position.
Mr. Crawford. Okay, that is very helpful.
Now, on the other side, call option.
Mr. Claussen. It still falls under the same----
Mr. Crawford. Same deal.
Mr. Claussen. Yes.
Mr. Crawford. Okay, so there is no differentiation
between----
Mr. Claussen. Because they are options----
Mr. Crawford. All options are the same.
Mr. Claussen. Right.
Mr. Crawford. The reason I ask that is because I have had
this crazy idea that if you could get farmers to, and they are
already long actuals, so if they could take that short position
and create more liquidity in the market, that it would reduce
volatility. Would you agree? Does that make sense to you?
Mr. Hesse. Again, I am not an economist so I shouldn't
speculate on that aspect.
Mr. Crawford. Let me ask the economist then.
Does that make sense to you, because we have gotten the tax
position fairly well clarified, so now can we see the value to
a producer to use a hedge strategy that is manageable with puts
and calls versus open futures contracts?
Dr. Williamson. The financial markets is not an area where
I am really comfortable commenting on right now.
Mr. Crawford. Okay. All right, well, I am going to switch
gears, but that is a theory I think that----
Mr. Hesse. Mr. Crawford, if I may.
Mr. Crawford. Yes.
Mr. Hesse. One of the difficulties that we do have on the
tax side though is establishing whether we have a hedging
arrangement or whether it is a speculating arrangement.
Mr. Crawford. Sure. And they are going to be treated
differently based on whether they are a bona fide hedge or not.
And I would think for the purposes of ag producers, they would
certainly qualify as bona fide hedgers.
Mr. Hesse. But there is also the----
Mr. Crawford. There are speculators that is true, and I
think that that is where we need to make some clarification to
make sure that they were, in fact, bona fide hedgers for the
purposes of hedging their crop versus taking a speculative
position. I certainly appreciate that difference there.
Let me switch gears real quick. We had a downturn in
commodity prices and it has really kind of stretched our farm
bill resources to the limit. Let me ask you if you think it
would be a good idea, and this is particularly true with cotton
producers who didn't have title I protection, but do you think
it would be a good idea if we were to implement some sort of a
tax-incentivized, tax-beneficial savings account for farmers to
use in conjunction with the policies that we have in place, so
they could essentially effect their own disaster relief in a
time when maybe there is a weather disaster or in our current
market scenario where prices are so low? Is that something you
would support?
Mr. Hesse. Certainly, we would. The ability of managing
your own money, deciding how much to set aside into a farm and
ranch risk management account, for example, setting that aside,
taking a deduction for placing that money into a separate
account, and then deciding on when to pull that out as another
technique or another tool to use for smoothing the income so
you don't have the income spikes and the valleys, would be
beneficial.
Mr. Crawford. I am going to do a shameless plug here and
say that in H.R. 1400 I would ask for you all to research that,
H.R. 1400, which essentially does just that. And in the context
of tax reform, I think that would be a good positive move to
put one more tool in the toolbox for farmers as a risk
management tool.
Finally, real quick, the preferential capital gains rate in
1986 and 1993 tax bills for some reason excluded the timber
industry, and created a disadvantage for corporate holdings of
timber. The 2015 PATH Act included a 1 year reprieve for C
corporations harvesting timber and restored equity to the
industry. Do you think it is important to preserve equity for
businesses with similar assets within a similar industry so no
one is at a disadvantage?
Mr. Hesse. I certainly believe in the same taxation across
different entity types, and to the extent that C corporations
don't have a special capital gains rate and the individuals do,
that I would be in favor of having a similar type of a benefit
for the C corporations.
Mr. Crawford. Do you think we should probably look at that
to consider that provision of the PATH Act to be made
permanent?
Mr. Hesse. From a personal standpoint, I am, again, in
favor of the equality so, therefore, the answer is yes.
Mr. Crawford. Thank you. I appreciate it.
I yield back.
The Chairman. The gentleman yields back.
Mr. Panetta.
Mr. Panetta. Thank you, Mr. Chairman. Gentlemen, ma'am,
thank you very much for your time today, your testimony,
preparation, and for being here. I appreciate that.
My questions are going to revolve around the estate tax,
just to let you know.
I come from the central coast of California. Land prices
there are very expensive. Just to get things clear, if I could
have a show of hands, are all of you for the elimination of the
estate tax?
Dr. Williamson. I don't have an opinion. ERS does not have
an opinion.
Mr. Panetta. Okay, understood. Mr. van der Hoeven?
Mr. van der Hoeven. I am on the fence because with roughly
$5\1/2\ million per each, and $11 million total between the
two, I think that covers over 99 percent of us. If we get rid
of it completely, what does that say? I am not seeing it in the
people that I talk with. Although I am working with a family
where the issue relative to value is three things; location,
timing, location. The family has an appraisal, 2010, $780,000.
Mom died last October unexpectedly. They now have an offer on
the table for 116 acres of 430 at $10.5 million. Now they are
facing an estate tax issue. It is a champagne problem to have.
Mr. Panetta. Understood. Understood. Please.
Mr. Hesse. From my viewpoint, the estate taxes doesn't
raise any significant amount of money, and yet there are
significant resources that go into structuring, planning over a
long period of time. We generate fees from doing that, but I
view it as a deadweight loss to the economy, in order to
structure the arrangement such that we keep below the threshold
of the $5.5 million. Therefore, since it doesn't raise that
much, it seems that it would be more efficient to the economy
to eliminate it, and so that we don't have the deadweight loss
that is associated with planning around it.
Mr. Panetta. Well, could you see an instance where some
tweaks may help it, either raising the amount, or raising the
percentage?
Mr. Hesse. I can't comment on that.
Ms. Wolff. AFBF is committed to repealing the estate tax.
When the exemption was raised to $5 million a few years ago,
that was very helpful, and it does cover most farmers and
ranchers but it doesn't cover all, it picks winners and losers.
And farmers who come from areas of the country that have higher
land values are the losers.
Second of all, as Mr. Hesse mentioned, estate planning is
an expense that we believe is a waste of resources. As long as
the tax is on the books, most farmers believe they have to plan
for it because most farmers I know want to grow their
businesses and they plan to be successful, and the $5 million
sets a line where you are a winner or you are a loser. And as
long as the estate tax is there, it hangs over the heads of
young farmers. They know that they want to stay in the
business, but they have to worry about what will happen when
their farmers die. And it is a cloud hanging over our industry
that we don't need, and if it is right to eliminate the tax for
99 percent of farmers, we should go the whole way.
Mr. Panetta. Now, I was a former prosecutor, and obviously,
I try to take into account the other side when I go into a case
and to know their argument. And I am sure you know the argument
of the other side. Give me the argument of the other side, and
how do you rebut that, for keeping it?
Ms. Wolff. Well, I don't want to assume that I am answering
your question, so could you state your argument?
Mr. Panetta. Well, obviously, there has to be some argument
out there for keeping the estate tax, correct? And I would
imagine being in your position, being against it, you would
know that argument.
Ms. Wolff. Well, there are philosophical arguments. To us,
this is not a philosophical argument, it is a business
argument; whether or not a farm and ranch can continue to the
next generation. We look at this as a business issue, not a
philosophical one.
Mr. Panetta. Understood.
Mr. Claussen. I just want to make a comment as it relates
to estate tax, and also the argument for current estate tax
provisions, and it is the argument of stepped-up basis in the
assets that are in the estate. The estate tax at current levels
does not affect everybody, and Ms. Wolff testified to that.
However, stepped-up basis does affect everybody that dies with
assets. If removing the estate tax also means we are removing
stepped-up basis in those assets, we need to give some
consideration to what are the implications as it relates to
American agriculture.
Mr. Panetta. Fair enough.
Thank you. I yield back my time.
The Chairman. Mr. Dunn, 5 minutes.
Mr. Dunn. Thank you, Mr. Chairman.
We are talking about taxes here, and sometimes it is
helpful to quantify the universe we are talking about. I am
wondering if any of you has ever seen or conducted a
comprehensive analysis of what the farmers and ranchers of the
nation generate in terms of tax revenue. And I am not talking
about just the taxes they pay and their families pay, but also
the taxes on all of the economic activity they generate, so
taxes from manufacturers, retailers of tractors, seed, soil
amendments, insurance, all of these people, the people who
process and market their crops, all of that economic activity,
has anybody got an eye on what the tax revenue on that economic
activity is? Yes, sir.
Dr. Williamson. Mr. Dunn, well, we have not conducted an
analysis on that, but we are able to maybe provide you
something in writing. We do have estimates of the taxes paid on
land and government fees, so we estimated that agriculture pays
about $15 billion a year, and will pay in 2017.
Mr. Dunn. Real estate tax?
Dr. Williamson. And real estate taxes and fees, and
property taxes.
Mr. Dunn. Okay, this is a minuscule portion of the taxes
that are paid by----
Dr. Williamson. Yes.
Uunfortunately, we do not have an estimate on the total tax
revenue from the economic activity of agriculture and the
allied sectors.
Mr. Dunn. As we go forward and we are talking about tax
reform here, enthusiastically, I think that it behooves us to
understand what is the universe of economic activity that we
are affecting.
Dr. Williamson. Yes.
Mr. Dunn. Also I kind of want to change back to the
foresters, we touched on briefly, and I thought we were going
to address this, but it actually didn't. The tree farmers
actually don't have the ability to deduct or expense the
reforestation expenses that they incur as they replant forest
after they harvest. Of course, they almost all need to replant
after they harvest. I want to ask your opinion: does this seem
like a fair deduction, a business expense. Anybody?
Mr. Hesse. The timber taxation, of course, is different
from agricultural farming taxation, even to the extent, for
example, we may call it a Christmas tree farm, that comes under
a timber taxation set of rules. But you are correct that the
reforestation direct costs aren't directly deductible. After
the planting, the trees are established, then all of the
growing expenses from that point forward are deductible,
similar to the growing costs of other farm assets.
So as to the extent of what it should be, I can't speak to
that as policy.
Mr. Dunn. Well, I assure you our foresters feel like they
are farmers. Yes, they don't plant quite as often or harvest as
often, but they think of it like a farm.
Mr. van der Hoeven.
Mr. van der Hoeven. They are allowed to deduct $10,000 per
year, per unique tract. As a management thing, they could go in
and subdivide their tracts and be able to capture that.
Anything over $10,000 is then amortized over 84 months. I would
argue that they would be able to recover their reforestation
expenses within 7 years.
Mr. Dunn. Another torturous avoidance of tax.
Thank you very much. Mr. Chairman, I yield back.
The Chairman. The gentleman yields back.
Mr. Lawson, 5 minutes.
Mr. Lawson. Thank you very much, Mr. Chairman. I want to
thank you all for being here today.
And this question probably goes to Dr. Williamson. Dr.
Williamson, given that so many small farmers have off-farm
employment that often provides health insurance benefits, the
percentage of farmers who use the self-employed health
insurance deduction is relatively low. However, those who do
are likely to choose an insurance option from the Exchange set
up by the Affordable Care Act. Would repeal of ACA result in an
additional burden on full-time farmers?
Dr. Williamson. Thank you for the question. You are correct
that many of farmers; small, new farmers, as well as
established farmers have off-farm jobs, and while some of them
receive their insurance from off-farm sources, from an
employer, there are many that purchase their insurance on the
private market and pay out-of-pocket for that insurance. I
can't answer the question of what the market would look like
post-ACA if it was terminated, without knowing more information
about the state, which state they are in, but I would say that,
yes, many farms do choose to purchase on the market, and any
reduction could make it difficult, I guess, for them to find
insurance.
Mr. Lawson. All right. Did anyone else like to comment on
that? Okay, the reason why I asked that question, when I came
here to Congress one of the reasons, having been in the
insurance business for over 36 years, is I wanted to really
work on a fix for the Affordable Care Act because we knew that
there were problems, especially in Florida and some other
places. And we haven't made any progress yet, but I thought
that if the people who have businesses, especially some of the
farmers and so forth, this would be a good time to see if we
can bring out some of the information. Are they looking to
lower their premiums, are they looking with prescription drugs,
how does it affect the farming industry, because most of the
time a lot of work that farmers are doing is so independent
than everybody else, trying to get their crops to market, and
at the same time providing courage and support for their
families. What do most of the farming community do in terms of
getting proper health insurance benefits for their families?
Mr. Hess. As a result of the legislation at the end of
2016, Congress passed H.R. 34, I believe the number was, to re-
establish the ability of having health reimbursement accounts
for those employers that have fewer than 50 full-time employees
and full-time equivalents. I think that goes a long way to
helping the small employers for agriculture to re-establish the
opportunity of providing some health insurance and health and
medical expense deductions against their taxes that hadn't been
available under the original Affordable Care Act. And farmers
do have the self-employed medical deduction available to them,
to the extent that they have income from their farming
operation, they can deduct the self-employed health insurance,
and also health savings accounts are available to agriculture
as well.
Mr. Lawson. Okay, in the timber industry, which I have in
between two cities, Tallahassee and Jacksonville, Florida, the
timber industry it is a long-term investment, and because it is
a long-term investment, the ability to deduct interest for that
long-term investment. How, with what is being proposed, will
this curtail or have any harm on the timber industry? Mr.
Hesse, would you like to comment on that? Anyone?
Mr. Claussen. Nothing? Okay. Well, I appreciate the
question about the interest deductibility. And I would say the
timber industry would be in the same boat as the rest of the ag
economy as it relates to interest deductibility. We have
investments in long-term assets with a limited amount or no
equity capital that comes into the system. Everything has to be
provided from debt financing, and, therefore, the interest
deductions would become a significant portion of what their
operating cash-flow is, or where it goes.
Mr. Lawson. I yield back.
The Chairman. The gentleman yields back.
Rick Allen.
Mr. Allen. Thank you, Mr. Chairman. And thank you, panel,
for being with us today and taking your time to talk about the
tax situation.
I tell you what, I know now why we haven't done tax reform
in a long, long time, because it affects, it seems like we need
a different Tax Code for every business.
But as far as the estate tax, obviously, it affects not
only farm but construction and many, many other businesses. As
far as the argument for or against the estate tax, I mean if
you sell the farm, and you had a large capital gain, I mean
wouldn't that come under the capital gains application?
Mr. van der Hoeven. Well----
Mr. Hesse. Generally, well, go ahead.
Mr. van der Hoeven. Go ahead.
Mr. Hesse. Well, with respect to the assets that are the
long-term assets from the land, the real estate assets,
certainly, those would be the capital gains. But then to the
extent that there is so much in agriculture, especially
depending on what period of what time of the year you die as to
whether you are holding a growing crop, are you holding
inventory, are you holding accounts receivable, had you sold
the crop, valuation on that specific day, an unexpected day,
but it would be ordinary income.
Mr. Allen. But you don't debate that. In other words, the
IRS says you owe this much money, right, as far as estate taxes
go? I mean in other words, the IRS will come in now and do a
complete evaluation of the family members' assets, and the
children then are required to write a check based on that
evaluation.
Mr. Hesse. Yes.
Mr. Allen. Regardless of whether the farm is worth, right
now, say, if you are growing cotton, it is not worth a lot of
money, for example.
Mr. Hesse. There are provisions within the estate tax for
paying of the estate tax over a 14 year period of time delay,
interest-only for the first 4 years, and then 10 year payout
for that portion that is associated with the farm, but still an
unexpected cash-flow hit, as Representative Noem testified, as
to how do we finance this, and this liability which hangs over
which affects the ability of obtaining other finances.
Mr. Allen. Yes. And it does affect a lot of, well, mostly
small businesses pretty much.
Mr. Hesse. Yes.
Mr. Allen. Getting back to this interest deduction, will
the interest deductibility offset the gain from immediate
expensing? Is it any expensing benefit?
Mr. Hesse. We don't believe so. Section 179 is at a high
enough level today that, as one witness testified, the large
percentage of farms are already able to deduct and expense-off
their equipment purchases during the year. The tradeoff of
allowing full deductibility of fixed asset purchases in
exchange for interest isn't a benefit for agriculture.
Mr. Allen. Yes.
Ms. Wolff. Mr. Allen, if I could add, there is no immediate
expensing for land.
Mr. Allen. Okay.
Ms. Wolff. When a farmer would have to take out a loan to
buy land, there is no immediate expensing there. So there is
certainly no tradeoff there.
Mr. Allen. Okay. As far as immediate expensing, is there a
value to agriculture for immediate expensing versus the various
depreciation options out there?
Mr. Hesse. Certainly, there is, with the flexibility that
is available for Section 179, how much of that do I want to
claim, and as a planting opportunity, another tool in the
toolbox, if you will, of smoothing out the income, and
expensing-off or choosing to depreciate the equipment assets or
depreciable real estate assets that are required.
Mr. Claussen. And I would like to just add a comment, that
immediate expensing in contrast to depreciation expense is
really a timing difference, because it is not giving you the
option to deduct items that you couldn't depreciate before, it
is just now you are doing it on a more accelerated schedule.
Mr. Allen. Right. Right.
Dr. Williamson. Mr. Claussen, I would just like to add,
concurring with my panelists that for the most part farmers are
able to, if they have income offset, offset that income
immediately with expensing and plus bonus depreciation. For the
farms that do surpass the expensing limit of $500,000 today,
they still have benefitted up until that $500,000.
One thing we haven't talked about is that there is a phase-
out for Section 179, but it doesn't hit until they make an
aggregate investment of $2 million, and then it starts to
phase-out dollar for dollar, which effectively doubles the tax
rate during the phase-out period.
Mr. Allen. Okay. Thank you.
The Chairman. The gentleman's time has expired.
Mr. Soto.
Mr. Soto. Thank you, Mr. Chairman.
If we had a carve-out for the estate tax simply for
agriculture businesses, do you think that would satisfy what
you all are concerned about, about a lot of these farmers
having to divide up their land or plan for estate the whole
time they are in business?
Ms. Wolff. That has been tried once before several years
back. It was called QFOBE, qualified family-owned business
exemption. It was an attempt to carve-out farmers and ranchers
and small businesses. It didn't work. It was very complex, it
had a long set of rules, farmers were afraid to use it because
it was so complex, and that they would be subject to challenge
by the IRS. Certainly, a much simpler way, and a way that we
believe is a better way, is to repeal the tax.
Mr. Soto. Any other input on that?
Dr. Williamson. Well, sir, I can give you a little
perspective on who would be affected by this potential carve-
out. Well, based on our information we have from surveying
farmers annually, well, there is a small percentage of farm
estates are going to be liable for the tax, so it is less than
one percent, but the liability that there is will fall mainly
on mid-sized and larger farms. Just giving a little bit of a
context in terms of who is affected currently, and who we
potentially see as affected by any kind of provision, such as
the carve-out.
Mr. Hesse. I am somewhat concerned, Mr. Soto, with regard
to if we have a sector, and we will call it agriculture, that
is exempt from the estate tax, and now we have what Mr.
Peterson identified starting off as that you have non-
agricultural interests will be flocking into agriculture to
acquire those assets that might qualify for any carve-out that
is there. Once we start running provisions for a carve-out of a
particular sector, what are the unintended consequences from
other investment money coming into that, which perhaps would
drive up, again, the prices of the inputs, prices of the fixed
assets and the investments in agriculture.
Mr. Soto. The reason why I asked that is because there is a
lot of sympathy for, and we have had ranches in my own district
that have had to be split up just to pay the estate tax. And we
know that farmers have a very unique place in America to make
sure that we have an adequate food supply, but when we are
lumping them in with multibillion dollar hedge fund managers
that are suddenly now not paying estate tax, there is far less
sympathy when you include this entire group, as opposed to
these even larger Mom and Pop farms that help feed America. And
so it would be much more tolerable to have an estate tax
exemption for true agricultural industries. And maybe there is
a way to make it less complex and to avoid the gamesmanship,
but lumping in our American farmers who have a true issue, with
giant hedge fund managers and other major wealthy families that
are in the billions and billions of dollars, all in this estate
tax issue, is obviously a much harder lift and harder to get a
lot of people onboard for.
So any particular reaction to that, I would be happy to
hear.
Mr. Claussen. Yes, Mr. Soto, I really appreciate the
sentiment of doing a carve-out for farmers or agriculture
because there are certain provisions where that has been
effective, and so I appreciate that sentiment. If there is a
way to make it effective so that there isn't abuse by those
that are not involved in farming, or fundamental changes in
what a farmer is doing over their lifecycle, and let me give
you an example. A number of farmers will spend 50 years of
their life actively, day-to-day involved in the farming
operation. They are on the tractor every day, so to speak. And
then maybe in the sunset portion of their career, maybe they
become more of a landowner that is renting their farm ground
to, say, their son or nieces or nephews, so it is still
farming, but would they be characterized as a farmer when
technically they are a landowner that is collecting rent. Those
are some of the implications that we would want to be cautious
of. But I do want to commend you for your sentiment of carving-
out farmers or agriculture with some of these special
provisions. I appreciate that.
Mr. Soto. I yield back. Thank you.
The Chairman. The gentleman yields back.
Mr. Marshall, 5 minutes.
Mr. Marshall. Thank you, Mr. Chairman. First of all, I want
to compliment the Chairman and the Ranking Member for getting
some great witnesses. It is very, very helpful for me to have
two people from the Ways and Means Committee come over first.
It was very helpful. I can't think of two better people to talk
about agriculture and taxes in the same subject. Congresswoman
Noem, I got to hear her very harrowing story several years ago,
when I didn't know I was going to be a Congressman. Certainly,
she grew up in agriculture, tragic accident, lived through the
death tax issue, and ran a big farming operation. It is great
to have her over on the House Ways and Means.
Congresswoman Jenkins, there is not a brighter tax mind up
here. It is great that our Chairman has tax experience as well.
Congresswoman Jenkins, people may know, grew up on a dairy, so
she understands agriculture, and as a CPA understands tax
policy.
Great to see American Farm Bureau Federation here.
Certainly, the voice of agriculture. Couldn't think about doing
tax issues in agriculture without talking to Farm Bureau.
Kennedy and Coe was founded in Salina, Kansas, as I recall,
in my district, in the 1930s. Certainly, one of the most
respected agriculture accounting firms in the country, and I
appreciate your expertise.
I am sure I have talked to thousands of ag people, I
represent the largest ag-producing district in the country, and
they constantly tell me that without cash accounting they would
go broke. There is no other way to do it. They talked about the
importance of deductibility of interest, the estate tax I
mentioned already, unlimited expensing and preservation of
section 1031.
Ms. Wolff, is that unique to Kansas, is it unique to
farming, is it unique to cattlemen and dairy as well, or does
it influence one more than the other, or is it all a big
priority for Farm Bureau?
Ms. Wolff. Well, you have outlined AFBF's priorities for
tax reform. It seems like a long list, but it is really not
when you consider all of the things that are being discussed in
tax reform. We have tried to focus on those that are most
important to farmers. And being a general farm organization,
they have application to all commodities, all types of farms.
So while there may be some, I would say the different
commodities would put them in a different order, I believe that
they all are important across the board.
Mr. Marshall. Okay. Mr. Claussen, I can't help but ask you,
you certainly represent a very diverse group of people too.
What are your thoughts? Is it going to influence dairy as well
as cattle, as well as hogs, as well as other commodities?
Mr. Claussen. Mr. Marshall, I really appreciate the
question, and setting the stage as it relates to who the
panelists are, and your background and the district that you
represent.
As I think about farm operations over the years, I think
about how they have become much more specialized. It used to be
that you would have a farm operation, and he would maybe have a
few cows, a few hogs, he would do a little corn, a little
wheat, he would even have a few chickens running around. That
is not the farm economy of today. That is not the farmer of
today. They have to have more specialization because of the
sophistication that is required for their operation.
And as I think about things like cash accounting, that is a
very reasonable and simplified method of tracking what their
income is, right, cash-in and cash-out. Maybe have a few
differences because of deprecation and things of that nature,
but for the most part it is a very simplified method of
tracking their taxable income. I appreciate the question.
Mr. Marshall. Yes. Yes, last, let's just talk about
stepped-up basis. It is a very misconceived situation. And the
other misconception is that people don't realize farming is
business. And I can't emphasize that enough, farming is a small
business. It has worked a lot with the community banking in the
past, it is absolutely one of the most complex businesses going
around right now. I want to talk about stepped-up basis just a
little bit more to make sure everyone understands how important
that is in the agricultural industry. Mr. Hesse, you want to
grab it?
Mr. van der Hoeven. Well, I would just offer this example,
Mr. Marshall, and that is let's say I inherited a tractor for
$70,000, and if I got stepped-up basis then I would be able to
start depreciating that on my date, which would reduce my
taxable income for the 7 years. If I did not get stepped-up
basis, but again, $70,000, and let's assume $10,000 over then I
am going to have $10,000 more income over a 7 year period,
because I don't get that depreciation.
Mr. Marshall. And very few farmers wouldn't have to sell a
section of land just to pay some of these tax consequences if
we didn't have stepped-up basis, or whatever the issue is.
Mr. van der Hoeven. Right. Possibly, yes.
Mr. Marshall. Okay.
Thank you, Mr. Chairman. I yield back.
The Chairman. The gentleman yields back.
Ms. Kuster.
Ms. Kuster. Thank you very much. And thank you to the panel
for being with us.
The risk of going late in the hearing is that you may have
already covered this, but there is a great deal of discussion
right now about a possible border adjustment tax. My district
in New Hampshire, is on the northern border with Canada. We
have a lot of trade back-and-forth, and including our
agricultural products: cheese, dairy, fruits and vegetables,
that type of thing, as well as a very big timber interest. And
it would be helpful for me to understand, any of you, your
perspective on the impact on the border adjustment tax both to
the sort of small farm trade that we have in New Hampshire;
organics, farm-to-table, that type, as well as I would be
curious for Mr. Marshall's district in Kansas, with the larger
operations and commodities and such.
Ms. Wolff. The border adjustment proposal is proposing a
change to our Tax Code to tax revenue where it is consumed,
instead of where it is produced. And the tax benefit goes to
the company that is exporting or importing. If a company
produces something in the United States that is sold overseas,
the revenue from that sale is not taxed as income. And if a
company is importing a product, then the cost of that import is
not deductible. It changes the income tax of the importing or
export company.
The tax is designed to give us a competitive advantage in
export sales. That is a very positive thing for any commodity
that has sales overseas, which is almost all commodities, to
some degree, depending on your specific commodity it may be
more or less.
On the flipside then, there is an increase, or at least in
the short-term until there is adjustment, an increase on
supplies that we import; fertilizer, fuel, those kind of
things.
So there are very positive aspects about it. There are some
things that are concerning. The proposal is actually not
written down yet, it is being talked about in concept, and so
until we know exactly what the proposal is, it is hard to say
one way or the other the impact it will have on our industry.
Ms. Kuster. Any other members of the panel wish to comment?
Mr. Claussen. Yes, I would just like to make a comment as
it relates to if we look at the umbrella of all of agriculture,
it is going to be difficult to assess if a border adjustment is
a positive or a negative for all of agriculture, because you
point out, Congresswoman, a distinct difference in what we
would call agriculture. One is you have folks that are
exporting products that are right next to the border, they have
an understanding of what is being exported. In fact, in many
cases, the producer may be the exporter. They are able to take
advantage of some of those advantages.
Now, you take Mr. Marshall in Kansas, take Hard Red Winter
wheat, Hard Red Winter wheat grown in Kansas is the same kind
of Hard Red Winter wheat that is grown in Nebraska or Oklahoma.
It is hauled to the elevator, it is put on a train, it is
hauled to the Gulf, it is hauled out to the PNW and then put on
a barge and exported. There is not enough information available
to say which farmer produced that grain in Kansas, and can they
get that benefit. The benefit would be to the direct exporter.
That creates one of the challenges and one of the frustrations
with border adjustment because that information doesn't get
back to the actual producer and provide a direct benefit at
that point.
Ms. Kuster. That is extremely helpful. Thank you very much,
in our quest to understand what the tax reform may mean to
different people. Thank you very much. I appreciate it.
I yield back.
The Chairman. The gentlelady yields back.
Mr. Arrington, 5 minutes.
Mr. Arrington. Thank you, Mr. Chairman. I find this hearing
very helpful to me. I have a lot to learn on this subject for
sure, and I do appreciate the panelists lending their expertise
and their insights.
Let me start with health care, just because we are in the
middle of this healthcare reform, discussion, debate. I really
hope we can move that forward for all Americans, not just
farmers and ranchers. But my understanding is that there are
some 14 taxes that are repealed in this American Healthcare
Act. This is the reform and repeal of ObamaCare. What do your
clients say about this draft legislation that we have not voted
on yet, but just in terms of the provisions out there
specifically, repealing almost $1 trillion in taxes, 14 is the
number of taxes, what are your clients saying about that, and
how that would help or hurt, and support their viability and
growth or inhibit it? Yes, Mr. Hesse.
Mr. Hesse. Probably the one that is most public or affects
the most number of our clients may be the net investment income
tax. We are still working through, quite frankly, just what is
subject to the net investment income tax and what is not, what
relationships, what type of income am I receiving, and is it
excluded, is it included: 3.8 percent, it is one of the higher
rate taxes that is part of the Affordable Care Act, and there
is some hope that that would be repealed retroactively back to
January 1, 2017.
The medical device excise tax is certainly important in the
Minnesota region, but most of these taxes are not direct on
agriculture, is really the issue, and it is the mandates that
are more important.
Mr. Arrington. Pardon me for interrupting, but just in
terms of having small family farms and relatively small
operations, and under that rubric of small businesses, et
cetera, I mean do you generally, without getting into the
details of it, because this is in the Health, Education, Labor,
and Pensions Committee, do they generally favor repealing these
taxes and radically departing from this current construct under
Affordable Care Act, or do they want to keep Affordable Care
Act? Not affordable care, the Affordable Care Act. Just
generally, can anybody speak to that? Maybe the Farm Bureau
members.
Ms. Wolff. Our members have goals for healthcare reform,
and they deal with two areas. One is access and one is cost.
Farmers tend to live in rural areas, and that is where the
access issue comes from. They need to be able to have services.
They don't want to have to travel great distances to get the
care they need, and so access is the first point.
The second point is then they have to be able to afford
those services. And so as an overreaching goal of any
healthcare reform proposal, we are looking for things that
bring healthcare costs down.
Mr. Arrington. Do they generally think that a repeal of the
Affordable Care Act will make headway to that end, or do they
think leaving the Affordable Care Act will make headway to that
end?
Ms. Wolff. The American Farm Bureau does support repeal of
the Affordable Care Act.
Mr. Arrington. Thank you very much.
When I think about agriculture and farm country, like west
Texas where I come from and the district I represent, we don't
have the people that other communities have to support
infrastructure, but what we have is product. Product the
American people need, and product this country needs for
economic growth, and most importantly for national security;
food, fuel, and fiber, but without health care, for example,
infrastructure we can't sustain that. There are unique
challenges, and you all would agree with rural infrastructure.
But with ObamaCare, it has brought $58 billion in additional
regulatory costs, and rural hospitals, which are the center of
care for rural communities, are going away, they can't handle
the strain and the cost. Any comments about that in particular,
anybody?
I yield back to the Chairman.
Ms. Wolff. I can only repeat what I said before, and that
is that the concern of farmers and ranchers is two-pronged. We
need access, so we need a strong rural healthcare system, and
we need to be able to afford it. And so any reforms that
Congress enacts in health care should move us in that
direction.
The Chairman. The gentleman's time has expired.
Ms. Plaskett, 5 minutes.
Ms. Plaskett. Yes, thank you, Mr. Chairman. Good afternoon,
gentlemen and ma'am.
I wanted to ask you, there has been a lot of discussion in
this hearing about border adjustment taxes, and if a border
adjustment tax is adopted and if the dollar appreciates, as
proponents of the Blueprint say it will, I don't really see how
this is going to help our ag exports. We know that agriculture
struggles with low prices already, and the export market is one
of the bright spots in agriculture. I don't believe that I am
alone in this thought.
Senator Grassley told reporters this week, ``You aren't
going to hear anything about border adjustments in the Senate
Finance Committee.'' I am not entirely sure if that is the same
statement that we will hear here in the House. And what would
the effect of removing the border adjustment tax from this plan
be, where would funding come from? Wouldn't proponents need to
find another source of revenue to offset the reduction rates it
receives elsewhere from the plan? Do any of you have any
thoughts on that? Ms. Wolff?
Ms. Wolff. It is true that the border adjustment proposal
is one of the major revenue raisers.
Ms. Plaskett. Yes.
Ms. Wolff. It is one of the major contributors to making
the tax reform plan revenue-neutral. And there would have to be
significant changes if border adjustment were not included.
Either the size of the package would have to be pared-back, or
other sources of revenue would have to be found. And I don't
know the answer to your question as to how that would happen,
but you have certainly framed the question.
Ms. Plaskett. Yes. I got that right, at least. I got the
question right.
Mr. Claussen. Thank you for the question. I am going to
speak a little bit to the pay-for provision if border
adjustment is removed or scaled back. In my testimony, both in
the written testimony and in the oral testimony, I talked with
regard to the importance of cash accounting for farmers and
ranchers. Cash accounting, back in 2013 there was a proposal to
require accrual accounting for all businesses, and that
provision would have generated a substantial amount of revenue.
Ms. Plaskett. Yes.
Mr. Claussen. Now, if you take the Blueprint and you read
through its provisions, it does not require accrual accounting.
In fact, it is really an advocate for the cash basis of
accounting. But one of the concerns that we have had is that as
comprehensive tax reform is undertaken over the next few months
and year, perhaps that question will come up, is if border
adjustment is something that it is not able to be decided upon,
what are some of those other provisions. And so I wanted to
share testimony with regard to the importance of cash
accounting, and why farmers and ranchers need to continue to be
able to use that as a tool. I wanted to share that with you.
Ms. Plaskett. Okay. The other thing when you talk about, we
all know that farmers need different sorts of accounting than
maybe someone in another type of business; a computer business.
Thinking about investments where a farmer is making an
investment every 10 years for a large piece of equipment, as
opposed to a computer which would be every year or every 2
years, depending on the use of it. Can you talk to me about
what would happen if the Code changes so that the amount that
the business buys a product, and instead of writing off the
cost over time, there has to be an immediate tax write-off on
that, and it is not something that they are able to spread out
over time, would that have a significant effect on farmers and
how they adjust their taxes according to their investments?
Ms. Wolff. A couple of points. First of all, it is
important for farmers and ranchers to be able to match up their
income and expenses.
Ms. Plaskett. Yes.
Ms. Wolff. Farm income fluctuates greatly. There may be 1
profitable year, followed by many that are not, and it is the
matching of income expenses and leveling out that income that
is important.
Ms. Plaskett. You need time to be able to do that, right?
Ms. Wolff. You need, well, you need flexibility to match up
your income----
Ms. Plaskett. The flexibility of----
Ms. Wolff.--and expenses. What happens when that is not
possible, as farm income spikes, if you receive all of your
income over 5 years, if you have 1 year that is very profitable
followed by 4 that are not, if you can't even out your income
then the taxes you pay are more than someone with a steady
income, because you are realizing all of your income in 1 year,
and you would be at a very high rate that year. We need
provisions in the Code to help farmers even things out, and
match up the income and expenses so that there is a more
equitable taxation and so that they can manage their cash-flow.
Ms. Plaskett. Okay.
The Chairman. The gentlelady's time has expired.
Ms. Plaskett. Thank you.
The Chairman. Mr. Faso, 5 minutes.
Mr. Faso. Thank you, Mr. Chairman. Last, hopefully not
least. I thank the witnesses for being here today, and I
appreciate your testimony. Before the hearing today, we had a
hearing in T&I for 2 hours, and I spent an hour there and come
over to this one for an hour. I appreciate your indulgence.
Mr. Hesse, did I understand you to say that you didn't
think there was, that you had a preference for Section 179 over
the notion of 100 percent expensing?
Mr. Hesse. If the tradeoff were 100 percent expensing as a
tradeoff for non-deductibility of interest. That is the
proposal that we would not have deductibility of interest
expense incurred by businesses, but we would allow everyone to
expense-off their asset acquisitions and depreciable asset
acquisitions.
Mr. Faso. Yes.
Mr. Hesse. We would not be in favor of that in the aspect
because most of the farmers today are able to utilize Section
179 to expense-off the equipment purchases anyway. And so to
use that as a tradeoff to satisfy or as an advantage as a
tradeoff against the non-deductibility of interest is a no-go.
Mr. Faso. Got it. And that gets to what Ms. Wolff was
saying in terms of the interest being so important for land
purchases.
Mr. Hesse. Agriculture is so cyclical that you have all of
these inputs incurred up-front, and raising of the funds, the
finances in order to fund the purchases of the feed, seeds,
fertilizer, et cetera, raising the animals, raising the crops,
and not having that income for a year or 2 years later, the
interest expense incurred in order to raise the funds to
finance those inputs, that is what makes it an interest expense
critical, just on the operational side let alone on in the
acquisition of the land.
Mr. Faso. Got it.
Ms. Wolff. And Mr. Hesse was talking about that a tradeoff
is being proposed. The point that I had made earlier is that
there is no immediate expensing for land.
Mr. Faso. Right.
Ms. Wolff. Therefore, there is no tradeoff. And land is
probably the biggest purchase that a farmer will make, it is
the reason that they would incur the most debt, and it is that
expense then would be large and would have to be something they
would have to account for in their business. It would make
lending money, borrowing money harder and more expensive.
Mr. Faso. Thank you, I appreciate you both clarifying that
point.
And the other point that was raised by Mr. Soto relating to
the estate tax, and, Mr. Hesse, you previously mentioned the
compliance costs to comply with the estate tax, compared to the
amount of revenue the Federal Government derives. My
recollection is it is a very small difference between what
individuals and businesses pay to comply with these estate tax,
versus what the Federal Government receives. Could you expound
on that?
Mr. Hesse. I don't know the statistics as to the cost of,
not only just complying with the estate tax, but also all of
the planning that goes along with the desire to avoid or reduce
the effects of the estate tax. I don't know, Dr. Williamson, if
you have the statistics as to just what the costs are in that
aspect versus the amount of revenue that is derived from the
Federal Government.
Dr. Williamson. We do not have any information on that.
Mr. Hesse. Yes, okay.
Mr. Hesse. Sorry.
Mr. Faso. Mr. Claussen?
Mr. Claussen. Just to comment on the revenue side.
Mr. Faso. Sure.
Mr. Claussen. In 2015, Federal estate tax generated
approximately $17 billion in revenue. And information was just
reported the other day from the IRS that for 2016 the estate
tax generated $19 billion of revenue, which is far less than
even one percent.
Mr. Faso. Right. And my recollection, which is always
hazardous to rely upon, but my recollection is that the
compliance costs for the economy were somewhere in the
neighborhood of the amount that the government raises.
Mr. Claussen. Yes, that----
Mr. Faso. What really the motivation of some in terms of,
or the rationale of some, I don't want to talk about
motivation, the rationale of some to justify this, they want to
penalize those rich people, as they perceive it, as opposed to
producing a tax exercise which is actually efficient and
economical and logical for the economy. I think that is really
what it comes down to; we spend as much to comply with it
societally in the economy as the government collects. I
appreciate your statements here.
Mr. Claussen. In 2016, the same report showed that there
were 36,000 estate tax forms filed, Form 706, and for 2015
there were only 5,000 of them that actually owed any tax.
Mr. Faso. Right.
Mr. Claussen. There was a significant compliance cost with
no tax due.
Mr. Faso. Thank you.
Mr. Chairman, I yield back.
The Chairman. The gentleman's time has expired.
Mr. Thompson, 5 minutes.
Mr. Thompson. Thank you, Mr. Chairman. And thanks to
members of the panel for being here, lending your expertise and
thoughts on this important topic.
Ms. Wolff, I want to start with you. Are you familiar with
the use of Section 1031, the like-kind exchanges, in the
context of conservation easement transactions, and if so, can
you explain how they are utilized to the benefit of the
taxpayer?
Ms. Wolff. Yes. First of all, let's establish like-kind
exchange. That is a deferral of tax when a business sells an
asset, real property, and purchases another similar asset. In
agriculture, that is land, it is equipment, and it is animals.
Like-kind exchange rules also apply to conservation easements.
If a farmer sells a conservation easement, the money that he
receives from that sale is eligible for like-kind exchange
treatment and can be used to purchase a like-kind asset.
Mr. Thompson. Okay, thank you.
Mr. van der Hoeven, much of your testimony concerns how to
help older adults retire while protecting their businesses.
What can we do to help younger farmers, that next generation,
good succession planning, we need that next generation to make
sure we are well fed and clothed, and all the good things that
come off of farm and ranchland. What can we do to help younger
farmers choose to enter farming, in addition to helping older
farmers retire?
Mr. van der Hoeven. Well, thank you for the question. One
of the things I suggest is maybe modifying Code Section 529 to
allow individuals who may not desire to go on to university to
develop their human capital, but to allow them, and
grandparents or parents, to make an investment in a tax-
deferred account to create a down payment fund, if you want to
look at it that way. Capped at some value, say, $100,000, and
if they bought a $300,000 farm then they could use the $100,000
as a down payment. They would not get basis for that $100,000
because they have already received a tax benefit, but it would
give them some startup cash, kind of some bootstrapping, and
they could start that as soon as they are born. We have parents
and grandparents that establish 529s for education.
And that is one suggestion.
Mr. Thompson. Mr. Claussen, why is debt financing so
important to the agriculture community, and what do you think
happens to agricultural producers without the ability to deduct
those mortgage interest costs?
Mr. Claussen. The reason that debt financing is so
important because there is no other alternative. Equity capital
is generally not attracted to agriculture because of
volatility, low returns, it is very capital-intensive. The only
way for a farmer or rancher to generate capital is either to
earn it over time or to borrow it from a lender.
Specifically, if you think about land cost: land cost, if
you are an ag producer and you are getting started in the
operation, or in an operation, you are going to want to own
some farmland, and typically, farmland is not available all the
time, right? They are not making any more farmland, and so you
have to be selective on when you are purchasing that ground.
You have to utilize debt financing in order to acquire that
ground, and then operate it. And typically, you are going to be
financing 70 to 75 percent of that purchase if you are a
younger farmer, and that generates a significant amount of
interest expense that then would not be deductible.
Mr. Thompson. Mr. Claussen, just in the time I have left,
you talked about net operating loss carrybacks and
carryforwards, why are these provisions important to
agricultural producers?
Mr. Claussen. That is a good question. I appreciate you
bringing that up. I gathered just a little bit of data, this
speaks to the volatility in farm income. The USDA did a 2017
Farm Sector Income Forecast and they forecast net income to be
$62.3 billion for farmers. Now, if you contrast that with 2013,
net farm income in 2013 was $123.7 billion. Here we are 4 years
later, and net farm income is forecast to be \1/2\ of what it
was in 2013.
The rules that I believe Mr. Hesse shared in his statement
with regard to farmer net operating losses, they have the
ability to carry those losses back 5 years as opposed to 2
years, which would be for most other taxpayers and businesses.
Because of that volatility, the 5 year carryback is critical
for our ag producers.
Mr. Thompson. Thank you.
Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired.
Mr. LaMalfa, 5 minutes.
Mr. LaMalfa. Thank you, Mr. Chairman. I appreciate, again,
parachuting in from one Committee to the other, so I am sorry I
didn't get to be here for the whole panel, very little of it.
But following up, Ms. Wolff, on the section 1031 situation,
it can be very important for ag producers, and I am not sure
what is going on, what may happen with tax reform on that being
around, but obviously, it is an important tool. How unique is
agriculture in its usage of that, in what is more or less a
deferment of tax, it is more like basically swapping land
instead of just an outright sale, the way the tax works. How
unique is agriculture's usage of this type of tool compared to
other industries or other property transfers that might occur
in this country?
Ms. Wolff. First of all, the tax reform Blueprint, the
proposal, is silent on like-kind exchanges.
Mr. LaMalfa. Which makes it scary.
Ms. Wolff. Which means we don't know how they will be
treated. Certainly, like-kind exchanges are important for
farmers and ranchers because, as you said, they allow a farmer
to defer the tax when they are swapping, and that is a good
word, that is a word that a farmer would use, trade equipment,
upgrade their livestock, and land. If you look at the coalition
that is working for like-kind exchange, it is very broad. It is
very important to agriculture, but agriculture is not the only
industry that is impacted. If you think about any other
industry where they are trading equipment back-and-forth, it is
very important to those groups too.
So certainly, it is not unique to us, but it is a very
important tool for farmers to have to upgrade, keep their
businesses effective, operating effectively, and up-to----
Mr. LaMalfa. Is there something more unique or more
difficult, or a higher hurdle for farmers, or why it has that
have even more urgency than maybe other industries or other
properties? Do you see a bigger challenge?
Ms. Wolff. I do not. Does anyone else?
Mr. LaMalfa. Others?
Mr. Claussen. Sorry, we all want to talk. I will keep mine
brief so that there is time for other comments. One of the
challenges that agriculture has is the fact that if you are a
farming operation, you have a certain radius of land that you
are going to be able to farm, and if you have the ability to
reposition some of your farmland assets, maybe take a piece
that is further away and move it closer, or reposition it for a
higher quality piece of farm ground, you are going to do that
because you are geographically limited.
Mr. LaMalfa. I get you loud and clear. We are fortunate
everything is contiguous on my place, pretty much.
Mr. Claussen. Yes.
Mr. Hesse. And because agriculture is so heavily dependent
upon the farmland in the first place, such a large percentage
of the investment is going to be in the farmland, so it makes
sense, although I don't know the statistic as to how much
agriculture uses Section 1031 for real estate exchanges versus
other industries.
Mr. LaMalfa. Okay, thank you.
I, unfortunately, got to miss most of the exchange on the
border adjustment. Dr. Williamson, would you like to elaborate
on any point that hasn't been made today, a little more on
that? I guess where I would want to go with it is if we
tailored it a little bit better to our agriculture, it could
either be shielded or even benefit, what would that look like
on making, if it is going to be there, what would work in order
to have a coexistence?
Dr. Williamson. Well, ERS doesn't have recommendations for
a policy for a border adjustment tax. It has been laid out
pretty well that it the relationships are very complex, so
there is a relationship with the producers, the growers, with
the exporters, and the relationship with other trading
partners. It is certainly unclear who is going to benefit and
who is going to lose. And a lot of this has to do with the
competition of the relationships between all these players.
Mr. LaMalfa. Thank you.
Others on the panel that might want to weigh in, as I am
running out of time? No? No takers? Well, okay. Well, I
appreciate it.
And thank you, Mr. Chairman, for the time, and I yield
back.
The Chairman. The gentleman yields back.
I want to thank our witnesses, including our former Members
who were here earlier to talk to us this morning. You have
clearly demonstrated why tax reform is hard and why it is going
to be a difficult path to walk. What I have asked my colleagues
to do is to keep their powder dry until we get all of the
details necessary to be able to run the kind of projections
that certainly my two CPA colleagues would do for their clients
in terms of what they would look like under the new scheme all-
in versus what they looked like under the old scheme, and where
the advantages and disadvantages are. Thank you for helping us
point that out.
Lowering rates and spreading the base is kind of like going
to heaven; everybody wants to go there, just nobody wants to
die to get there. And so every one of those credits or
deductions or special treatments has an advocacy group, as you
have heard from this morning. Our Code is more complicated
today than it was in 1986, and it is inefficient, we use it,
collectively, to manipulate behavior, manipulate conduct,
manipulate the economy, incentivize this activity,
disincentivize that activity. All of that is inefficient in the
extreme. And so if you believe that the only reason to have a
Tax Code is to collect the minimum amount of money needed to
fund the government, this system isn't it. But it is the system
we have, and so Kevin Brady and his team are hard at work on
it. The healthcare reform will take about $1 trillion of taxes
out of the overall reform effort that we are going to debate
later. If we don't get that done then everything you have
talked about this morning with respect to the tax reform plan
will be dramatically different because we will have to fold in
all those ObamaCare taxes into the new mix.
But I really appreciate, especially my two CPA colleagues.
My license is still current, by the way. I still get the 40
hours of CPA, no exemptions. I am the most dangerous tax return
preparer anywhere because I only do one, and that is the last
guy you want doing your taxes is mine.
So again, I thank the folks for being here. This just sets
the stage for a lot more conversations, especially as it looks
at the unique aspects of agriculture, and all of the things
that go on there with respect to the Tax Code and how important
it is to get it right. Thank you very much for your efforts on
our behalf, and I look forward to future conversations with you
as the tax reform proposal begins to gain additional
definition. Thank you all very much.
I have some official words to say. And they are, under the
Rules of the Committee, the record of today's hearing will
remain open for 10 calendar days to receive additional
materials and supplementary written responses from our
witnesses to any question posed by a Member.
This hearing of the Committee on Agriculture is adjourned.
Thank you all.
[Whereupon, at 12:23 p.m., the Committee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Article by Hon. Collin C. Peterson, a Representative in
Congress from Minnesota
House GOP Tax Reform Plan: A Case Study
By John L. Buckley
John L. Buckley is a former House Ways and Means Committee
chief tax counsel and a former member of Tax Analysts' board of
directors.
In this report, Buckley uses the farm sector of the U.S.
economy as an example of how the House Republican Blueprint for
tax reform would affect capital-intensive small businesses. He
concludes that farmers could be among the large losers from the
Blueprint plan--a result that is not positive from a political
or economic perspective.
Tax Notes Special Report
Tax Analysts 2017. All rights
reserved. Tax Analysts does not claim copyright in any public
domain or third party content.
Table of Contents
I. Introduction
II. Uncertain Claims of Economic Growth
III. Description of Blueprint
A. Personal Income Tax Changes
B. Business Tax Changes
IV. Tax Impact on Farmers
A. Few Farmers Would Benefit
B. Tax Increases on Many Farmers
C. Collateral Consequences
V. Negative Effects of Import Tax
VI. Border Adjustments Invite Trade War
VII. Conclusion
I. Introduction
The House Republican Blueprint for tax reform released before the
2016 election is a combination of tax policy ideas borrowed from prior
tax restructuring proposals.\1\ The changes to the personal income tax
are largely drawn from the 2014 tax reform legislation introduced by
former House Ways and Means Committee Chair Dave Camp. The basic
structure of the proposed business tax (with expensing for capital
expenditures, the disallowance of interest expense, and the continued
deductibility of wages) is very similar to prior flat tax proposals,
although in the Blueprint's business tax, those elements are grafted
onto a system of taxation that retains at least some significant
accrual features. Its border adjustments are an imperfect attempt to
mirror the border adjustments in VATs or retail sales taxes.
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\1\ For a description of the Blueprint and supporting materials,
see the House Ways and Means Committee web page. This report relies on
the full text of the Blueprint, which is part of those materials.
---------------------------------------------------------------------------
The business aspects of the Blueprint can be seen as a sharp
departure from current law, but they are an even sharper departure from
the 2014 Camp tax reform plan. His proposal was consistent with the
approach taken by the 1986 Tax Reform Act--namely, a reform of our
current system involving rate reductions financed by expanding the tax
base with the goal of not altering levels of projected revenues or the
distribution of tax burden. His proposal would have financed business
rate reductions by stretching out cost recovery for tangible and
intangible business investments. The Blueprint takes the opposite
approach, providing for immediate expensing. Camp's proposal failed in
the sense that it received little support from his Republican
colleagues in the House or from the business community. However, it did
perform an educational function, demonstrating the difficult tradeoffs
and political decisions required for such a reform, and the lack of
political will to make those decisions.
I have always viewed alternatives like the Blueprint as an attempt
to avoid the issues that condemned the Camp proposal to failure. Given
our extensive debates over tax policy and reform in the context of an
income tax, the winners and losers from the Camp proposal could be
quickly identified, with the losers more vocal and motivated than the
winners. Also, shifts in the tax burden across income categories could
be quickly analyzed. That is less true for proposals like the
Blueprint. There will be big losers and consequences that might not be
readily identifiable at the outset. Shifts in the tax burden can be
obscured by arguments over whether consumption-based taxes will be
passed on to consumers or offset by changes in the value of the dollar.
In that regard, comments made many years ago by former Senate Finance
Committee Chair Daniel Moynihan, at a hearing on flat tax proposals,
remain relevant today:
The idea of a new set of simple rules is always appealing.
However, any time a change of this magnitude is under
consideration with huge potential risks to the economy and
shifts of fortune in the balance, we must approach proponents'
claims with caution and healthy skepticism.
II. Uncertain Claims of Economic Growth
Healthy skepticism is especially warranted for claims that the
Blueprint would substantially increase economic growth. Those claims
rely on macroeconomic models that are based on assumptions that are
highly uncertain and in some cases even contrary to observable facts.
Assumptions often reflect the modeler's view of how the economy should
work rather than how it actually does.\2\ Speculation on how the
Federal Reserve, foreign countries or their central banks, or currency
markets would respond to the Blueprint may be critical to the growth
claims.\3\
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\2\ For example, some ``forward looking'' models assume that
individuals can predict the future with 100 percent accuracy. Those
models also tend to predict the most favorable growth responses.
\3\ Absent an extraordinary and immediate increase in the value of
the dollar, the Blueprint's border adjustment on imports would create
inflation in price levels, and the question of whether the Federal
Reserve would accommodate that inflationary price increase will be
critical to growth claims.
---------------------------------------------------------------------------
Projections of increased growth also will depend on assumptions
concerning existing law. The authors of the Blueprint have made it
clear that the numerous temporary tax provisions routinely extended by
Congress will be assumed to be permanent for purposes of budget
scoring.\4\ One would think that the same assumption should be followed
in modeling macroeconomic growth effects, but no one should be
surprised if that does not occur.\5\ A November 30, 2016, Goldman Sachs
report analyzed the impact of immediate expensing of capital
expenditures coupled with the disallowance of net interest expense (a
central component of the Blueprint).\6\ The report concluded that if 50
percent bonus depreciation were assumed to be part of the baseline law,
that component of the Blueprint would be neutral in the very short term
and result in lower investment in the long run. In other words, simply
extending bonus depreciation (and retaining interest deductibility)
would be more effective in encouraging domestic investment than the
Blueprint. A positive growth effect was projected if bonus depreciation
was not part of the baseline assumption.
---------------------------------------------------------------------------
\4\ See Blueprint at 16.
\5\ Indeed, the Tax Foundation has criticized the Goldman Sachs
report, infra note 6, because it assumed indefinite extension of bonus
depreciation. Scott Greenberg, Kyle Pomerleau, and Stephen J. Entin,
``Goldman Sachs Analysis of House GOP Blueprint Is Questionable'' (Dec.
5, 2016).
\6\ Goldman Sachs, ``U.S. Daily: Corporate Tax Reform: Trading
Interest Deductibility for Full Capex Expensing'' (Nov. 30, 2016).
---------------------------------------------------------------------------
Finally, on the issue relevant to this report, the models make
little or no attempt to analyze the effect of a proposal on the various
sectors of our economy, implicitly relying on the comforting assumption
that dislocations in one sector will be automatically offset by
increased growth in other sectors.
There is little question that the release of the Blueprint in
statutory form would be accompanied by claims of increased economic
growth, since it appears to be designed with the relevant models in
mind. But the more important question for policymakers is the
proposal's effect on our complex and interrelated economy, an economy
far different from the one assumed in many of the models. This report
uses the farm sector as a case study to analyze the real-world impact
of the Blueprint. There are several considerations that led to farming
being chosen for the case study. For example, the impact on farming is
emblematic of the adverse effects potentially experienced by many other
small businesses that rely on borrowed money to finance their
operations. There is also a practical reason for the choice: the wealth
of statistical information on farm income available online from the
Department of Agriculture.
At the outset, I want to be clear about some of the basic
assumptions underlying that analysis. First, this report assumes a
current policy baseline consistent with that in the Blueprint
description. Second, this report analyzes the Blueprint on a fully
phased-in basis, ignoring transition rules. In my opinion, transition
rules at best only delay the disruptive effects of a proposal and, in
attempting to do so, can add a new set of distortions. Finally, the
Blueprint description is expressed in very general terms, lacking many
details, so some educated guesses are required. I assume that current-
law accrual methods of accounting would be retained because their
repeal would be a significant change and likely mentioned in the
Blueprint description.\7\ That description states that expensing will
be allowed for ``new investment,'' possibly reinstating the distinction
between new and used equipment, which was a feature of the investment
tax credit repealed by TRA 1986. I believe that a more likely
interpretation of the term ``new investment'' is that both new and used
property would be eligible for expensing but that there would be anti-
churning rules to prevent large tax benefits from simply selling and
buying equivalent pieces of property.\8\ That is the interpretation
followed in this report.
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\7\ Repeal of accrual accounting rules may appear to be a
simplification, but for many corporations it would only add to overall
complexity because they would have to continue reporting earnings on an
accrual basis. Also, without complex transition rules, the shift from
accrual accounting to cash-flow accounting could result in double
taxation during the transition.
\8\ In prior flat tax proposals, the anti-churning rule consisted
of taxing the entire amount realized on the sale of property eligible
for expensing as ordinary gain, regardless of the adjusted basis of the
property.
---------------------------------------------------------------------------
Even a cursory examination of the Blueprint leads to the
inescapable conclusion that it was designed with total disregard for
its effect on farming:
Many farmers would see increases in both their income and
self-employment tax liabilities. Effective tax rates (as a
percentage of net income) would increase for many farmers, and
that increase would be significant for farmers struggling with
the impact of low crop prices or rising interest rates. The
rates would approach infinity in cases in which the proposal
would convert net losses into positive taxable income.
Financial industry experts predict that the Blueprint's
import border adjustment would result in some appreciation in
the value of the dollar and some cost inflation, since the
border adjustment would increase the after-tax cost of imported
items and cause domestic producers to raise their prices, as
well. As a result, farmers could experience both lower crop
prices because of dollar appreciation, and increases in the
cost of equipment and supplies such as fuel and fertilizers.
The border adjustments in the Blueprint are inconsistent
with our trade agreements and invite retaliation by other
countries, which could reduce access to overseas markets for
our farm products.
III. Description of Blueprint
A. Personal Income Tax Changes
The Blueprint's changes in personal income tax rules in most
respects are consistent with the approach taken in the Camp tax reform
plan. There would be a new rate schedule with lower rates and fewer
brackets. The itemized deduction for state and local income, retail
sales, and real and personal property taxes would be repealed, as would
all other itemized deductions other than the deductions for home
mortgage interest and charitable contributions.\9\ Nominally, those two
itemized deductions would be retained. However, they would be
effectively repealed for all but a few upper-income taxpayers because
of the effects of the repeal of the state and local tax deduction and
the conversion of personal exemptions (which are currently allowed in
addition to itemized deductions) into an increased standard deduction,
which would be allowed in lieu of itemized deductions.\10\
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\9\ One small example of possible unintended consequences involves
activities that are conducted largely for personal reasons but result
in some income (such as so-called hobby farms). Section 183 allows an
itemized deduction for expenses up to the amount of income. Under the
Blueprint, the section 183 deduction would be repealed in those cases,
resulting in a tax on gross income unreduced by expenses.
\10\ See John L. Buckley, ``The Hidden Repeal of the Mortgage and
Charitable Deductions,'' Tax Notes, Mar. 10, 2014, p. 1103.
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The plan would repeal the deduction for investment interest, a
repeal that could have a significant effect on financial markets.
The main departure from the Camp plan is in the taxation of
investment income. The Blueprint would allow a 50 percent deduction for
capital gains and dividends instead of the current preferential rates.
The new deduction would benefit all taxpayers other than those whose
capital gains and dividend income would fall in the 10 percent or 15
percent tax brackets of current law. Those taxpayers would appear to
lose the benefit of the current-law tax rate of zero percent for their
capital gains and dividend income. Interest income would also be
eligible for the 50 percent deduction.
B. Business Tax Changes
The new business tax contains elements that reflect a sharp
departure from current law, but describing it as a ``destination-based
cash-flow tax'' is misleading. It appears that many current-law
features that depart from cash-flow treatment, such as accrual
accounting and inventory rules, would be retained.\11\ As discussed
below, the border adjustments are flawed and would not meet the
``destination-based'' standard in many cases. Although perhaps over-
advertised, the Blueprint would make significant changes.
---------------------------------------------------------------------------
\11\ The Blueprint description proudly states that it retains last-
in, first-out accounting rules, apparently not recognizing that the
border adjustment on imports would cause many to revoke LIFO elections
because the basis of the most recently acquired imported property would
be zero.
---------------------------------------------------------------------------
The tax rate for non-employee business income (pass-through income)
reported on an individual return would be capped at 25 percent.
However, not all of that income would be eligible for the cap. The
portion of the income that represents reasonable compensation for the
individual's services would remain subject to the higher marginal
rates. Relying on an ill-defined concept like ``reasonable
compensation'' would introduce significant uncertainty and probably
result in endless litigation as taxpayers and the IRS disagree over
what is reasonable.
Capital expenditures (other than for land) would be expensed--that
is, immediately deducted in the year in which the property is placed in
service. The Blueprint description asserts that this change would ``be
equivalent to a zero percent marginal effective tax rate on new
investments.'' \12\ That sounds dramatic, but it is misleading.
Expensing would result in a zero tax rate only for marginal
investments, which are investments with an expected return slightly
above the taxpayer's cost of capital. For many small businesses, the
proposal would not provide greater benefits than the small business
expensing provisions of current law. Taxpayers not significantly
expanding their capital investments would receive a temporary increase
in cost recovery allowances before returning to annual allowances
comparable to those under current law.
---------------------------------------------------------------------------
\12\ See Blueprint at 23.
---------------------------------------------------------------------------
The Blueprint combines expensing with the disallowance of the
deduction for interest expense exceeding interest income (net interest
expense). This trade-off could be harmful for many capital-intensive
businesses and thus discourage investment. The Blueprint description
justifies the disallowance by stating that it would reduce the
incentive to borrow, implying that businesses could access equity
markets for business capital instead of borrowing funds. This ignores
the fact that equity capital is more expensive than borrowed capital
even for publicly traded corporations and is simply unavailable for
most small businesses.
Clearly, the most significant changes proposed by the Blueprint are
its border adjustments. The border adjustment on imports would impose
U.S. tax on imported products and services by eliminating deductions
for those products and services. In most respects this border
adjustment acts like an ad valorem tariff imposed on all imports, but
with two important differences.
First, a tariff is a tax-exclusive imposition, with the amount of
the tariff not included in its base. The Blueprint's border adjustment
on imports is a tax-inclusive system, with the tax included in its
base. For example, assume the importation of an item with a value of
$100. A tariff with a 20 percent rate would be $20, and the importer
could recover the tariff by selling the product for $120. With the tax-
inclusive border adjustment of the Blueprint, an importer attempting to
recover the amount of that adjustment under the proposed 20 percent tax
rate would have to sell the product for $125. Thus, the potential
increase in prices of imported products and services (and the effective
tariff) would be 25 percent, not the 20 percent tax rate.
Second, the Blueprint's import border adjustment would apply only
when the importer is a taxable U.S. business. Recently, I purchased an
item online, not realizing that the seller was located overseas. That
type of purchase would effectively be exempt from the Blueprint's
border adjustment on imports. Retail stores are increasingly under
pressure from online sales. In the future, domestic online sellers
could be at a substantial competitive disadvantage to foreign online
sellers.\13\ Large governmental entities or tax-exempt entities (like
tax-exempt hospitals and universities) could enjoy large cost savings
by directly importing supplies and equipment rather than purchasing
those items through domestic wholesalers. Even small tax-exempt
hospitals could enjoy large cost savings by purchasing imported
equipment and supplies through tax-exempt cooperative hospital service
organizations (section 501(e)).\14\
---------------------------------------------------------------------------
\13\ To protect its business model and obtain the same treatment as
its foreign competitors, Amazon might consider moving to Vancouver so
it could sell foreign-produced products directly to U.S. consumers
while avoiding the border adjustment on imports.
\14\ Theoretically, this problem could be solved by imposing an
actual tariff on imported goods when the importer is not a taxable U.S.
business. However, that tariff could be difficult to enforce,
especially for Internet purchases, and could be in direct violation of
our trade agreements.
---------------------------------------------------------------------------
There would also be a border adjustment for exported products and
services. Unlike a VAT, the Blueprint would not allow rebates of taxes
previously paid on exports. Instead, the amount received for the export
sale would be excluded from gross income, but expenses incurred in the
production of the export would continue to be deductible. Presumably,
the intent is to encourage exports by providing a subsidy in the form
of a negative tax that would permit exporters to provide a 20 percent
reduction in the price in dollars paid by the foreign purchaser. That
subsidy might be especially important as an offset to the increased
dollar value and increased costs faced by U.S. manufacturers or other
producers that could occur as a result of the Blueprint's import border
adjustment. For example, approximately 60 percent of imports are
intermediate goods \15\ used by U.S. businesses in the manufacture or
production of goods or services. But many exporters would simply lack
sufficient non-export-related taxable income to receive much benefit
from the export border adjustment. Absent economic distortive
transactions or mergers, for many exporters the export border
adjustment would largely result in loss carryovers that would be usable
only if the exporter sharply reduces its export sales in the
future.\16\ The Blueprint would increase the amount of those carryovers
by interest, an adjustment that would only increase the amount of
largely unusable loss carryovers.
---------------------------------------------------------------------------
\15\ Robert B. Zoellick, ``The Art of the Deal for Free Trade,''
The Washington Post, Jan. 6, 2017, at A14.
\16\ For example, according to the March 15, 2016, edition of the
Puget Sound Business Journal, in 2015 Boeing had export sales of
approximately $51 billion. According to its 2015 annual report,
Boeing's pretax income for 2015 was $7.155 billion. Thus, under the
Blueprint, depending on the level of imported components used in its
plane production, Boeing would have an NOL that could approach $44
billion.
---------------------------------------------------------------------------
The other significant changes in business taxation--a lower
corporate tax rate and territorial system of taxation--generally would
have little direct effect on the farm sector of our economy.
IV. Tax Impact on Farmers
A. Few Farmers Would Benefit
The effect of the new business tax on most farmers can be
summarized simply as the combination of a largely irrelevant benefit
(expensing) coupled with the detriment of a draconian disallowance of
net interest expense that exceeds the benefits of the individual rate
reductions.
Expensing allowed under the Blueprint plan is largely irrelevant
for most farmers. This is because section 179 already permits expensing
for tangible property used in a trade or business, subject to an annual
limit of $500,000.\17\ Few farmers have sufficient income to take full
advantage of the $500,000 limit on section 179 expensing, much less the
unlimited expensing that would be allowed under the Blueprint.
---------------------------------------------------------------------------
\17\ Although buildings and their structural components generally
are not eligible under section 179, special rules permit many farm
structures to qualify. For the definition of special purpose
agricultural or horticultural structures eligible for section 179
expensing, see section 168(i)(13).
---------------------------------------------------------------------------
The following table shows the average farm cash income (projected
by the USDA for 2016) for different farm sizes.\18\ Farm cash income is
a net income concept computed without regard to depreciation
allowances--a reasonable approximation of current-law adjusted gross
income from farming computed without regard to depreciation. Only the
group consisting of the top four percent of farmers has an average
income greater than the $500,000 limitation on section 179 expensing.
Even for many in that group, the Blueprint's expensing proposal would
be of little if any incremental benefit compared with the current-law
benefits of expensing for the first $500,000 of capital investment,
coupled with the bonus and accelerated depreciation methods for
investment exceeding that limitation.
---------------------------------------------------------------------------
\18\ USDA, ``Economic Research Service, U.S. and State Farm Income
and Wealth Statistics'' (Nov. 30, 2016). Except when otherwise
indicated, the USDA Economic Research Service is the source of the
farm-related statistics used in this report.
Table 1
------------------------------------------------------------------------
Share of Total Number Average Farm Cash
Farm Size by Gross Sales of Farmers Income
------------------------------------------------------------------------
$1 million or more 4.0% $685,400
$500,000-$999,999 4.0% $206,500
$250,000-$499,999 4.7% $103,000
$100,000-$249,999 6.9% $40,700
Less than $100,000 80.4% ^$500
------------------------------------------------------------------------
The Blueprint would repeal the NOL carryback. As a result, farmers
making equipment purchases exceeding their farm cash income would only
see increases in NOL carryovers.\19\ For example, if a farmer with
$200,000 in annual farm cash income made equipment purchases of
$500,000, under the Blueprint, the farmer would receive the benefit of
a $200,000 deduction for the year of the purchases and $300,000 in
deductions available in future years. In contrast, under current law,
the farmer would see immediate benefit from the entire $500,000, in the
form of a current-year deduction of $200,000 and the recovery of taxes
paid in the prior 2 years through $300,000 in NOL carrybacks.
Ironically, cost recovery allowances of some taxpayers would be
effectively deferred under a proposal advertised as providing immediate
write-offs of capital expenditures.
---------------------------------------------------------------------------
\19\ The Blueprint attempts to compensate for the repeal of loss
carrybacks by increasing carryovers by an interest rate factor. The
interest rate used would have to match the farmer's borrowing cost to
fully compensate for the loss of the carryback.
---------------------------------------------------------------------------
For the many farmers who would receive little or no benefit from
the new expensing provision (because they already can fully expense
under section 179), the question is whether the benefit of the rate
reductions would exceed the detriment of the proposed net interest
disallowance.
B. Tax Increases on Many Farmers
The AGI from farming for those who receive little or no benefit
from the new expensing provision would be substantially the same as
under current law, with the significant exception of the disallowance
of net interest expense. Whether there will be a net increase or
decrease in tax on farmers depends on levels of interest expense in the
farm sector in relationship to farm net income.
The USDA publishes a financial ratio--the times interest earned
ratio--to measure farmers' ability to meet their obligations to pay
interest on their debts. The ratio is net farm income (increased by
interest expense) divided by interest expense. It is a measure of how
much pretax income farmers have to meet interest payments. Net farm
income essentially is the same concept as farm cash income discussed
above, but with some accrual adjustments such as cost recovery
allowances. It is an imperfect but reasonable approximation of current-
law AGI from farming.
The times interest earned ratio also can be used to approximate the
average percentage increase in farm AGI that could result from a
disallowance of interest expense. For example, the times interest
earned ratio projected for 2016 is 5.4. A ratio of that size means that
farm interest expense is approximately 23 percent of average net farm
income, suggesting that average farm AGI would be increased by
approximately 23 percent because of the disallowance of interest
expense under the Blueprint.
Two caveats are in order concerning the 5.4 times interest earned
ratio projected for 2016. First, it is an average, and the debt levels
among farmers differ dramatically. A surprisingly large number of
farmers have no debt. However, the percentage of farmers with debt
rises significantly with farm size. Only slightly more than 20 percent
of farms with gross sales less than $100,000 have debt; the percentage
with debt grows steadily with farm size reaching approximately 75
percent for farms with gross sales of $500,000 or more. Because the
farms with gross sales less than $100,000 have an average net loss,
most farms with positive net farm income have significant levels of
debt, with the exception of older farmers who acquired their land many
years ago and have paid down the land acquisition debt. As a result,
for farmers with debt and positive net income, the times interest
earned ratio could be significantly lower than the average 5.4 figure,
with the result that for them the tax increase from a disallowance of
net interest expense could be greater than would be suggested by the
average 23 percent figure.
Second, the times interest earned ratio can vary dramatically
depending on economic conditions in the farm sector and interest rates.
In the 1980s the combination of high interest rates and low crop prices
resulted in the times interest earned ratio dipping below 2, suggesting
that disallowance of interest expense at that time could have more than
doubled average farm taxable income. As recently as 2011 the
combination of low interest rates and good crop prices resulted in a
times interest earned ratio approaching 10. Since then, the ratio has
steadily declined to 5.4, even with historically low interest rates. As
a result, effective tax rates on farmers (when expressed as a
percentage of net income) will be the highest during periods of farm
distress. The USDA statistics suggest that many American farms operate
at a loss. Under the Blueprint, some of those farms could face
significant income and payroll tax liabilities even though they operate
at an economic loss.
Farms operated as sole proprietorships or partnerships are subject
to the self-employment tax, and the income subject to that tax (self-
employment income) is determined under the regular income tax
rules.\20\ Because the Blueprint would not reduce self-employment tax
rates, all farmers with any interest expense would experience increases
in self-employment tax liability. The increase would be the greatest
for farmers with income below the Social Security wage base limit
($127,200 in 2017). Using the average 23 percent increase in AGI that
could result from interest disallowance, farmers with self-employment
incomes less than $100,000 under current law could face self-employment
tax increases of as much as $3,000.\21\
---------------------------------------------------------------------------
\20\ See section 1402(a).
\21\ The $3,000 amount is based on an average effective employment
tax rate of 14.2 percent, as shown in Joint Committee on Taxation,
``Overview of Federal Tax System as in Effect for 2016,'' at Table A-8
(May 10, 2016).
---------------------------------------------------------------------------
A basic assumption underlying the following analysis of the impact
on income tax liabilities is that farm AGI and farm taxable income are
equal. That assumption ignores non-farm-related income because the goal
is to isolate farm income and analyze whether the benefits of the rate
reductions for farm income exceed the detriment of interest
disallowance. It also ignores both the standard deduction and itemized
deductions of the very few taxpayers who would continue to itemize.
That is done for purposes of simplification, with the recognition that
the assumption understates the detriment of interest disallowance.\22\
---------------------------------------------------------------------------
\22\ The understatement is the result of the fact that an increase
in AGI will translate into a larger percentage increase in taxable
income.
---------------------------------------------------------------------------
Table 2 shows that even fairly modest levels of interest expense
could result in net income tax increases under the Blueprint. The table
is based on the 2016 rates for joint income tax returns. The table
includes a new rate bracket to reflect the effect of the new 25 percent
top rate for pass-through income, with the assumption that reasonable
compensation for the farmer's work is $125,000.\23\ For each rate
bracket, the third column shows the percentage change in tax liability
under the Blueprint for taxpayers with taxable income, assuming no
interest expense (referred to as EBI) equal to the midpoint of the
bracket. The fourth column shows the level of interest expense (as a
percentage of EBI) that would result in a net tax increase--that is,
the level of interest expense at which the tax under current rates on
taxable income determined with the deduction for interest expense is
lower than the tax at the Blueprint rates on taxable income not reduced
by interest expense. The last column shows the tax increases under the
Blueprint assuming that interest expense is 19 percent of EBI, the
percentage consistent with the 5.4 times interest earned ratio
projected for 2016.\24\
---------------------------------------------------------------------------
\23\ The assumption of $125,000 as reasonable compensation may seem
high, but it is not, because the 25 percent cap applies only when
taxable income exceeds $231,000.
\24\ As discussed above, a 5.4 times interest earned ratio
indicates that interest expense averages approximately 23 percent of
net income, which means that interest expense would be approximately 19
percent of the sum of net income and interest expense.
Table 2
----------------------------------------------------------------------------------------------------------------
Percentage Change Level of
for EBI of Interest Expense Tax Increase
Rate Brackets Current Rates Blueprint Rates Midpoint of at Which Net Tax With Interest at
Bracket Increase 19% of EBI
----------------------------------------------------------------------------------------------------------------
$0-$18,550 10% 12% 20% increase N/A $358.93
$18,551-$75,300 15% 12% 7.9% decrease 6.82% of EBI $835.94
$75,301-$151,900 25% 25% 6.7% decrease 4.7% of EBI $3,979.07
$151,901-$231,450 28% 25% 6.2% decrease 4.7% of EBI $7,510.92
$231,451-$356,413 33% 33% 5.1% decrease 3.84% of EBI $14,419.72
$356,413-$413,350 33% 25% 5.9% decrease 4.72% of EBI $17,754.52
$413,351-$466,950 35% 25% 9% decrease 7.11% of EBI $17,853.61
$466,951 and above 39.6% 25% a 18.04% decrease 13.91% EBI $11,371.01
----------------------------------------------------------------------------------------------------------------
a The table assumes the midpoint of this bracket is $600,000.
The table also assumes that setting aside the disallowance of
interest expense, taxable incomes will remain constant, since it
attempts to measure the impact on the large majority of farmers who
would receive little or no benefit from the Blueprint's expensing
proposal. That assumption also ignores changes to personal tax, an
assumption that significantly overstates the benefits of the rate
reductions proposed under the Blueprint. The Blueprint does not have a
zero rate bracket as the Blueprint description suggests; it has a much
larger standard deduction ($24,000) than current law ($12,000).
However, that increase is accompanied by repeal of the deduction for
personal exemptions.\25\ For a family of four, that means that the
entry point to the rate schedules begins at $24,000 rather than the
existing level of approximately $28,000. Itemizers would fare much
worse.\26\
---------------------------------------------------------------------------
\25\ The repeal of personal exemptions for dependents is
accompanied by an increase in the child credit, but that increase does
not alter the fact that the repeal of personal exemptions for
dependents reduces the benefits of the Blueprint's rate reductions by
increasing the amount of income subject to higher tax rates.
\26\ Many years ago at a closed bipartisan meeting on tax reform,
one of the Republicans on the Ways and Means Committee described the
tax reform plan then being discussed as a large tax reduction at the
top coupled with small tax increases on many others, with the hope that
no one would notice--not a bad description of the Blueprint plan.
---------------------------------------------------------------------------
The table results are not surprising given the pattern of the rate
cuts proposed by the Blueprint. Very modest levels of interest (as a
percentage of EBI) would offset the benefit of the rate reductions for
most income levels simply because the benefits of the rate reductions
for most income levels are fairly modest. Also, the amount of interest
expense (as a percentage of EBI) required to offset the benefits of the
rate reductions is always less than the percentage tax reduction from
the rate cuts because of the progressive rate structure of current law.
Even the large rate reductions at the top of the rate schedule would
not offset the detriment of an average 23 percent increase in taxable
income due to disallowance of interest expense until incomes exceed
$600,000.
C. Collateral Consequences
Farming is a cyclical business largely as a result of fluctuating
prices for crops and other farm products. The current income tax has a
countercyclical effect: little or no tax during periods of farm
distress but significant taxation during periods of farm prosperity.
The Blueprint would reverse that impact. It would accentuate cycles in
the farm sector instead of moderating them, potentially increasing
risks for farm lenders and creating additional pressure for
governmental farm relief during periods of low crop prices. For
example, with the rate schedule proposed by the Blueprint and a times
interest earned ratio of 2 (the level reached during the early 1980s),
the effective tax rate (as a percentage of net income) could approach
50 percent, even with the 25 percent cap on rates for pass-through
income.
Clearly, the disallowance of interest expense would increase the
after-tax cost of interest. A farmer in the 25 percent income tax
bracket could see a 33 percent increase in his after-tax interest
expense.\27\ There also could be an increase in rates demanded by
lenders because of increased risks of default. For example, the current
times interest earned ratio is 5.4, providing lenders a reasonable
cushion against potentially lower income in the future. The ratio is
computed on a pretax basis, which is consistent with current
deductibility of interest expense. With non-deductibility of interest
expense, the ratio should be calculated on an after-tax basis because
the interest disallowance means that only after-tax income would be
available to meet interest payments. For farmers in the 25 percent
income tax bracket, interest disallowance would result in a 25 percent
reduction in the income available to meet interest payments,
effectively reducing the current average ratio of 5.4 to approximately
4. Unless lenders are willing to accept higher risks without being
compensated for them, interest rates could increase.
---------------------------------------------------------------------------
\27\ For example, assuming an interest rate of six percent and a 25
percent marginal tax rate, the after-tax cost under current law would
be 4.5 percent. With the disallowance of interest expense, it would be
six percent, a \1/3\ increase from current law.
---------------------------------------------------------------------------
In the 2016 farm forecast, the USDA is predicting a modest decline
in farmland values because of lower projected net farm income. The
increase in actual and after-tax interest rates discussed above can
only place increased downward pressure on farmland values (because
buyer demand would diminish). As a result, all farmers, even those with
no debt, could be harmed by the Blueprint's disallowance of interest
expense. Transition relief, even if very generous, would probably not
ease the downward pressure on farmland values.
V. Negative Effects of Import Tax
As discussed above, the border adjustment on imports could result
in an effective price increase of 25 percent for imported products.
Absent currency adjustments, there seems to be little doubt that the
tariff equivalent would be passed on in the form of higher prices. The
liability for the border adjustment would be so large that the importer
could not absorb it by reducing profit margins. Most costs are fixed,
with the exception of wages, but wages are considered ``sticky'' and
thus not easily reduced. As a result, it is likely that the liability
would be passed on in the form of higher prices just as VATs are passed
on through higher prices.
In cases in which there is significant domestic production but not
enough to meet domestic demand, the price increase on imported products
could increase the price of the domestically produced product. An
example is crude oil. The price of domestically produced crude oil is
the world price with adjustments for transportation costs and quality
differences. The increase in the cost of imported crude oil because of
the border adjustment could result in higher prices for domestic
production and a windfall to domestic producers.
Economists who are proponents of the Blueprint's approach argue
strenuously that those cost increases will not occur because of
adjustments in the value of the dollar. It is an argument essentially
the same as the suggestion that flexible currency exchange rates would
eliminate trade imbalances--an argument unlikely to convince or calm
many. First, the upward adjustment in the value of the dollar would
have to be very large, 25 percent, to eliminate cost increases in the
United States.\28\ Second, flexible currency exchange rates were
introduced for the dollar and other major currencies in the early
1970s, but the United States continues to run large trade deficits, a
fact inconvenient to the theory that currency adjustments will
eliminate trade imbalances. Finally, many of our imports, like oil,
have a world price denominated in dollars, and upward adjustments in
the value of the dollar would not shield U.S. consumers from price
increases on those products.
---------------------------------------------------------------------------
\28\ Goldman Sachs, ``U.S. Daily: What Would the Transition to
Destination-Based Taxation Look Like?'' (Dec. 8, 2016).
---------------------------------------------------------------------------
Two prominent economists, Alan J. Auerbach and Douglas Holtz-Eakin,
recently argued that the value of the dollar would increase
immediately, with the result that there would be no domestic price
increases or reduction of imports because of the border adjustments in
the Blueprint.\29\ Rather than engage in a long discussion of why some
of their basic assumptions (such as the assumption that the import and
export border adjustments are equivalent) are highly unlikely to be
true in practice, I make two observations.
---------------------------------------------------------------------------
\29\ Auerbach and Holtz-Eakin, ``The Role of Border Adjustments in
International Taxation,'' American Action Forum, Nov. 30, 2016.
---------------------------------------------------------------------------
First, Auerbach and Holtz-Eakin present what appears to be a very
rosy scenario. The Federal Government would be collecting enormous tax
revenue from the border adjustment on imports, but none of that revenue
would come from cost increases on U.S. consumers or businesses.
Instead, the rosy scenario implicitly assumes that the burden of paying
those taxes would be shifted overseas through a sharp increase in the
purchasing power of the dollar with equivalent declines in the
purchasing power of other currencies. The Blueprint business tax
proposal may be destination-based since the import tax occurs only when
the product enters the United States, but under the rosy scenario the
liability seems to be origin-based.
Second, a report by Goldman Sachs presents a more realistic
picture, suggesting that the rosy scenario is neither likely nor all
that rosy. Their report concludes that an immediate adjustment in the
value of the dollar of a magnitude necessary to offset potential price
increases is unlikely and that if it were to occur, such a large and
abrupt change in exchange rates ``would deliver a sizeable hit to U.S.
residents' foreign wealth and could create risks of dollar-denominated
debt problems abroad.'' \30\ The Goldman Sachs report concludes that a
more likely outcome would include higher inflation coupled with some
dollar appreciation, suggesting that industries with low margins and
significant import purchases would be most vulnerable.
---------------------------------------------------------------------------
\30\ See Goldman Sachs, supra note 28.
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Neither scenario would be positive for U.S. farmers. Global demand
for U.S. agricultural product exports is expected to have declined in
2016 for the second straight year because of a combination of dollar
appreciation and slower economic growth overseas.\31\ Any future
increase in the value of the dollar would put downward pressures on
crop prices, and one can only speculate on the consequences of an
immediate 25 percent increase in the value of the dollar.
---------------------------------------------------------------------------
\31\ Congressional Research Service, ``U.S. Farm Income Outlook for
2016'' (Sept. 7, 2016), made publicly available by the Federation of
American Scientists.
---------------------------------------------------------------------------
Under the more realistic scenario, farmers could face both lower
crop prices (depending on the level of actual dollar appreciation) and
cost increases on any purchase of equipment or supplies when imports
constitute a significant portion of the U.S. market or when imported
parts are significant components of U.S. produced items. Farm
equipment, fuel, and fertilizers are among the items for which cost
increases could occur. Typically, farmers do not have the pricing power
that would allow those costs to be passed on in higher prices for farm
products.
It seems unlikely that the export border adjustment could offset
the negative effects of the import tax on the farm sector. Few farmers
directly export their products, so they would see little direct benefit
from the export border adjustment. It is unlikely that many farmers
would see any indirect benefit, since when they sell their products to
a process[o]r or trading company, it unclear whether the products will
be consumed domestically or exported. Many of the actual exporters
again may see little benefit because of insufficient taxable income
from other activities.
VI. Border Adjustments Invite Trade War
According to the USDA, export markets are critically important to
the health of the farm economy:
With the productivity of U.S. agriculture growing faster than
domestic food and fiber demand, U.S. farmers and agricultural
firms rely heavily on export markets to sustain prices and
revenues.\32\
---------------------------------------------------------------------------
\32\ USDA Economic Research Service, U.S. Agricultural Trade
Overview.
If the Blueprint were enacted with its border adjustments and those
adjustments were found to violate our trade agreements, U.S. farmers
could suffer a double hit: the lower crop prices and cost increases
discussed above, and likely retaliatory action by other countries that
could threaten overseas markets for domestic agricultural products. For
a foreign country, focusing retaliatory action on our farm exports
would have both strategic and political benefits; it would impose pain
on a politically sensitive sector of our economy while possibly
protecting a politically sensitive sector of the foreign country's
economy (farming) from competition from U.S. products.
Under our trade agreements, border adjustments are permitted if two
requirements are satisfied. First, those adjustments are permitted for
indirect taxes like VATs, excises, and retail sales taxes, but they are
not permitted for direct taxes like income taxes. Second, they cannot
be discriminatory, favoring domestic production over imports or
subsidizing exports. The border adjustments under the Blueprint would
violate both requirements.
It is clear that our current tax on business income (whether earned
by corporate or unincorporated entities) is a direct tax. The question
is whether the changes proposed by the Blueprint would change the
nature of our business tax so that it is an indirect tax on
consumption, like a VAT. Setting aside the border adjustments for a
moment, the proposed tax on business income under the Blueprint has all
the features of an income tax. As explained above, it is not a tax
purely on cash-flow. It retains a deduction for labor costs and appears
to retain the business deduction for state and local taxes, unlike
VATs. It retains incentives like the research credit, inconsistent with
the notion of a cash-flow tax. Because it is based on net income with a
deduction for wages, most economists would assume that it would not
increase prices on domestic production, just as they assume that the
burden of the existing corporate tax is not reflected in higher prices
but is borne primarily by equity owners, with a portion of that burden
shifted to labor in the long run.\33\ The business tax applies
regardless of whether business income is saved or consumed by business
owners. Indeed, one of the prominent supporters of the Blueprint's
approach describes it as a consumption tax except for consumption
financed with wage income,\34\ a rather large exception given that wage
income is a large percentage of total national income. The border
adjustment on imports has a consumption tax character, but it is a
consumption tax only on imported products. I believe that most
countries will accurately view the business tax proposed under the
Blueprint as an income tax with accelerated cost recovery and non-
tariff trade restrictions.
---------------------------------------------------------------------------
\33\ See J.C.T., ``Modeling the Distribution of Taxes on Business
Income,'' JCX-14-13 (Oct. 16, 2013).
\34\ PowerPoint presentation of Auerbach for conference on tax
reform, Tax Policy Center (July 14, 2016).
---------------------------------------------------------------------------
But there is little need to argue whether the new business tax is a
direct or indirect tax; its border adjustment on imports discriminates
against imports, and its export border adjustment attempts to subsidize
exports.
It is important to recognize that the border adjustment on imports
under a VAT results in equal tax burdens on both imported and
domestically produced products. In both cases, the ``value-added tax''
is the VAT rate times the value of the product. In contrast, the tax on
imported goods under the Blueprint would always be larger than the tax
on domestically produced products, assuming there are always some labor
costs, and it would be significantly higher if there are substantial
labor costs. For example, assume two identical products with a value of
$100 and labor costs of 60 percent, one imported and the other produced
domestically. The tax on the domestically produced product would be $8
(20 percent of the value of the product minus labor costs). The border
tax on the imported product would be $20.
Section 168(g)(6) authorizes the President to take limited
retaliatory action against any foreign country that maintains non-
tariff trade restrictions ``in a manner inconsistent with provisions of
trade agreements'' or that engages in discriminatory or other acts or
policies ``unjustifiably restricting United States commerce.'' The
import border adjustment under the Blueprint plan appears to be the
same type of non-tariff trade restriction for which section 168(g)(6)
authorizes retaliation: a restriction that at least in the past the
United States would not have tolerated if implemented by a foreign
country.
It also is important to recognize that the export adjustment under
a VAT merely rebates VAT imposed on the product during stages of its
production. The fact that the export adjustment is in the form of a
rebate means that the VAT is effectively eliminated regardless of the
exporter's tax situation. The rebate results in a zero tax rate,
appropriately, because the intent is to tax domestic consumption not
unlike a retail sales tax. Under the Blueprint, the amount received for
the export is excluded from gross income, but the costs of production
(including labor costs) remain deductible, resulting in a subsidy for
exports in the form of a negative tax rate. Using the example of a
product with a value of $100 and labor costs of $60, if the product
were sold domestically, there would be a tax of $8. If exported, there
would be a negative tax of $12 that could be used to reduce the tax on
products sold domestically. As discussed above, many exporters would
not receive the benefit of that subsidy, because they lack sufficient
taxable income from other activities. As a result, the Blueprint may
have a border adjustment that would violate our trade agreements even
though it would provide little or no benefit in many circumstances.
The question is how countries would respond if the Blueprint's
business tax scheme were enacted. The process for resolving trade
disputes can be lengthy and result in a delay of retaliation for years.
However, companies may be unwilling to increase investments in the
United States in response to the Blueprint's border adjustments until
it was clear that those adjustments would survive challenge. We could
experience the downside of trade protectionism (higher costs to
consumers and businesses, including farming) without the upside of
increased domestic jobs.
Some countries might see the enactment of the Blueprint as a
flagrant violation of trade agreements and retaliate regardless of the
niceties of the trade agreements. In either event, U.S. farmers could
experience reduced access to overseas markets.
VII. Conclusion
There are always winners and losers in any serious tax reform
effort. In the case of the current Blueprint proposal for tax reform,
farmers would be among the large losers.
President Truman in a fiery speech in Iowa during the 1948 campaign
accused the then Republican-controlled Congress of having ``stuck a
pitchfork in the farmer's back.'' \35\ It is hard to imagine what
rhetorical flourish Truman might have used to condemn the ``rough''
treatment accorded farmers under the Blueprint, but I believe that he
would have immediately appreciated the politics involved. And politics
will and should play a large role in the development of tax reform
legislation. Enacting a tax reform plan that is unsustainable
politically serves no one's interests.
---------------------------------------------------------------------------
\35\ September 18, 1948, speech at Dexter, Iowa, on occasion of the
National Plowing Match, available from the American Presidency Project.
Truman carried Iowa.
---------------------------------------------------------------------------
Clearly, there could be harmful economic dislocations in the farm
sector of our economy: downward pressures on farmland prices, increased
costs, lower crop prices because of dollar appreciation and loss of
access to foreign markets, and increased farm insolvencies with risks
to the farm credit system. And it may be small consolation to the farm
sector, but other sectors may also face negative effects from the
Blueprint. A research note on December 20, 2016, by JPMorgan identified
the ``automobile, computer, food, tobacco, petroleum, apparel, and
electronic sectors as among the most at risk by the plan.'' \36\
---------------------------------------------------------------------------
\36\ Brian Faler, ``Why Some Worry GOP Tax-Reform Plan Will Spark a
Trade War,'' Politico, Dec. 20, 2016.
---------------------------------------------------------------------------
Assessing the extent of those dislocations and whether they will
spill over into other segments of our economy should be part of any
attempt to measure the macroeconomic effects of a tax reform like the
one suggested under the Blueprint. Instead, the current macroeconomic
models simply assume that those dislocations will not occur.
______
Submitted Letter by William E. Brown, President, National Association
of REALTORS'
April 4, 2017
Hon. K. Michael Conaway, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Dear Chairman Conaway and Ranking Democrat Peterson:
On behalf of the more than 1.2 million members of the National
Association of REALTORS', and of our affiliate
REALTORS' Land Institute, I am writing to thank you for
holding a hearing tomorrow entitled ``Agriculture and Tax Reform:
Opportunities for Rural America.'' Tax reform is a major issue
affecting all real estate professionals, and there are some very
specific and serious concerns about how changes to our tax system could
impact agriculture, and especially agricultural land.
As I am sure you and all the Members of the Committee are aware,
Section 1031 of the Internal Revenue Code provides that property held
for productive use or investment may be exchanged on a tax-deferred
basis for property of like-kind. This provision provides for the
deferral of tax--not its forgiveness--until such time as the economic
investment is ultimately disposed of or ``cashed in.'' The like-kind
exchange has been part of our tax system since 1921 and is one of many
non-recognition provisions in the Code that provide for the deferral of
gain.
Like-kind exchanges are integral to the efficient operation and
ongoing vitality of many thousands of American farms and ranches,
especially in the land real estate sector. These agribusinesses, in
turn, strengthen the U.S. economy, provide jobs, and grow or raise
products that feed our nation and much of the world.
For land real estate, like-kind exchanges encourage land owners,
such as farmers and ranchers, to combine acreage, acquire higher-grade
land, or move into another property when they are ready to retire.
Moreover, section 1031 very often is the key ingredient in agreements
to set aside land for preserving open space, or for scenic or
environmental conservation purposes.
As you know, the House Republican tax reform ``Blueprint'' would
allow for the immediate expensing of business assets except for land.
Unfortunately, some proponents of immediate expensing believe that this
feature would supplant the need for like-kind exchanges. In reality,
replacing section 1031 with immediate expensing would leave land
investors, including family farmers and ranchers, out in the dust by
taking away their ability to do an exchange and also possibly
preventing the deduction of their interest expense.
The elimination or restriction of like-kind exchanges would
contract our economy by increasing the cost of capital, slowing the
rate of investment, increasing asset-holding periods, and reducing
transactional activity. NAR's members believe it would have a
particularly catastrophic effect on land transactions since land would
not be a permissible expense. Removing or inhibiting this tool would
likely translate into lower land values across the country, negatively
impacting rural counties' tax bases, and creating another real estate
recession--this time specific to rural counties explicitly because of
tax ``reform.''
In summary, there is a strong economic rationale for preserving
like-kind exchanges. Limiting or repealing section 1031 would deter
and, in many cases, prohibit continued and new real estate and capital
investment, particularly for land. Repealing or limiting like-kind
exchanges would dampen the motivation to buy, sell, and reinvest in
land and real property, and would cause significant capital to flee the
United States. This runs counter to the stated goals of tax reform to
increase economic growth, job creation, and global competitiveness.
This hearing is aptly and optimistically entitled ``Agriculture and
Tax Reform: Opportunities for Rural America.'' NAR believes that with
thoughtful leadership, tax reform will increase opportunities for all,
including those who make their living from one of our greatest
resources--the land. However, the opposite is also true, and
REALTORS' urge you and the Committee to help retain the
Section 1031 like-kind exchange as a vital tool for land investors, and
particularly for America's family farmers and ranchers.
Sincerely,
William E. Brown,
2017 President, National Association of REALTORS'.
CC:
Members of the U.S. House of Representatives Committee on Agriculture.
______
Submitted Letter by Stephen Chacon, President, Federation of Exchange
Accommodators, Et Al.
April 3, 2017
Hon. K. Michael Conaway, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Dear Chairman Conaway and Ranking Member Peterson:
We appreciate this opportunity to demonstrate the need to retain
I.R.C. Section 1031, in its present form, in any tax reform bill, even
if the bill includes reduced tax rates and full expensing of all
investment and business assets, as proposed by the House Republican
Blueprint for Tax Reform. Although the Blueprint proposes immediate
expensing with unlimited loss carryforward for all tangible &
depreciable personal property assets, including real estate
improvements, it would not permit land to be expensed. The Blueprint
proposals, taken as a whole, do not provide the same benefits, and are
not as comprehensive, as the benefits provided to taxpayers and our
economy by 1031 like-kind exchanges. Section 1031 will still be
necessary to fill in the gaps.
Like-kind exchanges benefit the agricultural sector in a myriad of
ways. Farmers and ranchers use 1031 to preserve the value of their
investments and agricultural businesses while they combine acreage,
acquire higher grade land, or otherwise improve the quality of their
operations. They rely on 1031 to defer depreciation recapture tax
when they trade up to more efficient farm machinery and equipment.
Farmers and ranchers trade dairy cows and breeding stock when they move
their operations to a new location. The ability to take advantage of
good business opportunities stimulates transactional activity that
generates taxable revenue for land brokers, appraisers, surveyors,
lenders, agricultural equipment dealers, livestock producers,
manufacturers and more. Please see Appendix for examples of
agricultural exchanges.
Repeal or restriction of like-kind exchanges would be especially
troublesome for agricultural investments, particularly because the
greatest value of agriculture operations is in the land, which often
has been passed down through generations. As a result, the land
generally has a very low basis and a sale would result in huge capital
gains that would not be offset by a deduction for improvements that may
be minimal in value, or non-existent, as in the case of raw land.
Without additional cash to cover both the tax liability and the new
investment, loss of 1031 would result in a government-induced
shrinkage of their agricultural business, retarding ability for growth
as well as the net worth of the farmers.
Retiring farmers also benefit by exchanging their most valuable
asset, their farm or ranch, for other real estate that doesn't require
a 24/7/365 workday, without diminishing the value of their life
savings. With a 1031 exchange, they can downsize or divest their
agricultural operation, and reinvest in other income producing real
estate, such as a storage unit facility, or a triple net leased
commercial property. The loss of 1031 would result in a direct
reduction of the retirement savings of these agricultural taxpayers, a
severe injustice to people who worked their entire lives on the land to
provide a modest living for themselves and food to feed our nation.
Most farmers, ranchers, land owners and real estate investors are
not ultra-high net worth individuals or large corporations. These
individual taxpayers do not have use for a large net operating loss
carryforward from the unused expense deduction for real estate
improvements. They do not have sufficient related income to offset the
expense, thus they would realize minimal benefit. These taxpayers will
face a massive amount of depreciation recapture upon sale, for which
they may not have sufficient liquidity, or may not have set aside
enough cash to satisfy, creating further personal challenges, locking
them in, and putting other wealth building options out of reach.
Like-kind exchanges make the economics work for conservation
conveyances of environmentally sensitive lands that benefit our
environment, improve water quality, mitigate erosion, preserve wildlife
habitats, and create recreational green spaces for all Americans.
Farmers, ranchers and other landowners reinvest sale proceeds from
conservation conveyances through 11031 like-kind exchanges into more
productive, less environmentally sensitive land. These socially
beneficial conveyances are dependent upon the absence of negative tax
consequences. Please see Appendix for examples of conservation
exchanges.
Unlike the Blueprint, 1031 provides a mechanism for asset sales
and replacement purchases that bridge 2 tax years. Absent 1031,
taxpayers would be forced to acquire new assets prior to year-end, or
be faced with recapture tax on the Year 1 sale and less equity
available for the replacement purchase in Year 2. This would create a
disincentive to engage in real estate and personal property
transactions during the 4th quarter, resulting in tax-driven market
distortions. Seasonal businesses benefit from exchanges in which assets
are divested in late autumn and replaced in early spring, at the start
of the new season, thereby eliminating off-season storage and debt-
service expenses, without any negative tax consequences or cash-flow
impairment. Like-kind exchanges take the government out of the
decision-making process.
At its core, I.R.C. 1031 is a powerful economic stimulator that
is grounded in sound tax policy. The non-recognition provision is
premised on the requirement that the taxpayer demonstrates continuity
of investment in qualifying replacement property with no intervening
receipt of cash. There is no profit-taking, and at the conclusion of
the exchange the taxpayer is in the same tax position as if the
relinquished asset was never sold.
Under current law, 1031 promotes capital formation and liquidity.
Two recent economic studies conclude that Section 1031 removes the tax
lock-in effect, and permits taxpayers to make good business decisions
without being impeded by negative tax consequences.\1\ Like-kind
exchanges stimulate economic activity--property improvements that
benefit communities, increase property values, and generate jobs
ancillary to the exchange transactions. These studies quantified that
restricting or eliminating like-kind exchanges would result in a
decline in GDP of up to $13.1 billion annually, reduce velocity in the
economy and increase the cost of capital to taxpayers.\2\ A Tax
Foundation report estimated a larger economic loss, at approximately
$18 billion per year.\3\
---------------------------------------------------------------------------
\1\ Economic Impact of Repealing Like-Kind Exchange Rules, Ernst &
Young (March 2015, Revised November 2015) available at http://
www.1031taxreform.com/1031economics/; and The Economic Impact of
Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate,
David C. Ling and Milena Petrova (March 2015, revised June 22, 2015),
available at http://www.1031taxreform.com/ling-petrova/.
\2\ Ernst & Young LLP, Economic Impact at (v) and Ling and Petrova,
Economic Impact, at 6.
\3\ Options for Reforming America's Tax Code, Tax Foundation
(2016), p. 79, available at https://taxfoundation.org/options-
reforming-americas-tax-code/.
---------------------------------------------------------------------------
Immediate expensing does not remove the lock-in effect on a host of
real estate owners. Land values represent approximately 30% of the
value of commercial improved properties, and up to 100% of agricultural
land investments. If these property owners are faced with reducing the
value of their investments and life savings through capital gains tax,
even with lower rates, they will likely hold onto these properties
longer.
Retention of 1031 in present form eliminates potential expensing
abuse. The proposal to fully expense real estate improvements in the
year of acquisition, with an unlimited carry forward, provides a
tremendous incentive at acquisition for a taxpayer to inflate the value
of improvements, so as to maximize the write-off. Conversely, upon
sale, there is great incentive to minimize the value of the buildings
and over-allocate value to the land, thus minimizing recapture tax on
the improvements at ordinary income tax rates, and benefiting from
lower capital gains tax rates on the land.
Appraising is not an exact science. There are different
methodologies, and a considerable amount of subjectivity, particularly
when there is a scarcity of market activity and relevant data upon
which to rely. Given the multiple variables that can impact appraisals,
land values, and structure values, appraisals can vary widely. A
taxpayer with a clear incentive could easily game the system to
maximize tax benefit and minimize taxes owed on disposition. Section
1031 eliminates this conflict and simply encourages reinvestment of the
full value.
In summary, like-kind exchanges remove friction from business
transactions and stimulate economic activity that would not otherwise
benefit from the proposed Blueprint. Section 1031 facilitates
opportunistic investment of capital and community improvement. Like-
kind exchanges assist the recycling of real estate and other capital to
its highest and best use in the market place thereby creating value and
improving the economic conditions for local communities, rural and
urban. Landowners and other businesses would be disadvantaged if they
had neither the option of a tax deferred exchange nor expense
deductions for land acquisition and interest on related debt.
Please feel free to contact any of us should you wish to discuss.
Sincerely,
Stephen Chacon, President, Federation of Exchange Accommodators; Vice
President, Accruit, LLC.
Suzanne Goldstein Baker, Co-Chair, FEA Government Affairs Committee;
Executive Vice President & General Counsel Investment Property Exchange
Services, Inc.
Brent Abrahm, Co-Chair, FEA Government Affairs Committee; President,
Accruit, LLC.
Max A. Hansen, Co-Chair, FEA Government Affairs Committee; President,
American Equity Exchange, Inc.
appendix
Examples of Agricultural and Conservation Exchanges
1. Combining Acres and/or Exchanging into Higher Grade Farms
Facts: A farmer owned two 80 acre tracts of farmland located 20
miles away from his home operation. Farmer's neighbor listed for sale a
160 acre, higher quality tract adjoining the farmer's ``home farm.''
Through a like-kind exchange, the farmer was able to divest the two
distantly located 80 acre parcels, acquire the neighboring 160 acre
tract, and combine his land holdings into a larger farm of 360
contiguous acres.
Impact: The like-kind exchange allowed the farmer to exchange into
the new farm without reducing his purchasing power, and provided him
with the ability to combine his acres, increase operational
efficiencies and add to the original family farm.
Conclusion: Section 1031 promotes reallocations of capital to
higher quality assets and results in greater operational efficiencies.
2. Keeping the Farm/Ranch in the Family--The Beginning Farmer
Facts: A 65 year old Farmer owned an 80 acre farm that had been in
the family for decades. When Farmer acquired the farm, land prices were
much lower. Farmer's son was a beginning farmer, starting his
operation. Through a like-kind exchange, Farmer sold the family farm to
Son and acquired a larger, higher quality parcel located near another
separate tract of farmland owned by Farmer.
Impact: The like-kind exchange allowed Farmer help his Son start
his farming operation while passing the family farm on to the next
generation. Farmer was able to sell the property to his son without
being ``tax locked'' due to negative tax ramifications if gain had not
been deferred.
Conclusion: Section 1031 encourages transitions of farmland assets
to new and beginning farmers.
3. Keeping the Farm/Ranch in the Family--Sibling Acquisitions
Facts: Five siblings inherited an undivided \1/2\ interest in two
600 acre tracts of ranchland (Tract A and Tract B) when their mother
passed away in the 1990s, subject to a life estate with father. Father
passed away in 2013 leaving the remaining undivided half to the
siblings. All of the siblings were left with equivalent tax
consequences in the event of a sale. Two of the siblings continued to
raise cattle on the tracts while three lived in other parts of the
country. The siblings decided to sell Tract A at auction with the
winning bidder agreeing to lease Tract A to the rancher siblings. The
three city siblings agreed to sell their interests in Tract B, the
``home ranch'' to their rancher brothers to keep it in the family. One
of the city siblings cashed out of her interest and paid capital gains
tax. The other two city siblings did like-kind exchanges into income
producing properties in their cities of residence.
Impact: The like-kind exchange allowed the two rancher siblings to
keep the ``home ranch'' in the family. At the same time Section 1031
incentivized the two city siblings to sell without fear of being ``tax
locked'' and reinvest in assets where they live that more appropriately
met their investment goals. Notwithstanding the opportunity to
exchange, the third city sibling made the best decision for her, which
was to liquidate the asset, pay the tax, and use the net proceeds for
other purposes.
Conclusion: Section 1031 promotes and incentivizes transitions of
farm and ranch assets to those who know and work the land for their
livelihoods. Fifty-five percent of land in many states is owned by
farmers and ranchers 65 year or older.
4. Diversification of Asset Type
Facts: Farmer built a 2,000 acre farmland asset base over the last
15 years with average values appreciating from $1,000 per acre to
$8,000 per acre. With farmland values approaching all-time highs,
farmer determined it was wise to diversify his portfolio and exchange
into depressed commercial assets nearby. Farmer sold a portion of his
farmland and exchanged into a storage unit facility, an apartment
complex and a retail strip center.
Impact: Section 1031 allows for exchanges into any real property
held for investment or used in a trade or business. Accordingly, farmer
was able to exchange into a depressed commercial investment and hedge
predicted downside risk to farmland asset values by exchanging into a
more diverse real estate portfolio.
Conclusion: The like-kind exchange serves as a diversification and
risk-hedging tool for all real property investors, including farmers
and ranchers.
5. Relocating Farm/Ranch and Livestock Operations, Keeping Investment
Dollars in the U.S.
Facts: An Amish couple owned 80 acres, a livestock operation and
their homestead and were relocating to an Amish community in another
state. The couple exchanged out of the land and buildings on their
current farm into a comparably priced farm in the new community.
Further, the couple exchanged their existing breeding stock into like-
kind breeding stock on their new farm.
Impact: Section 1031 allowed the Amish couple to pursue their life
plans and wholly continue their farming activities in their new
community without diminishing their purchasing power or ability to earn
a comparable living.
Conclusion: Like-kind exchanges enable property owners to relocate
their investment assets to best suit their business and personal needs,
without negative tax consequences. Section 1031 allows for exchanges of
like-kind investment or business-use property. Domestic property cannot
be exchanged for foreign property. Section 1031 promotes investment
within the United States.
6. Improvements to the Farm/Cattle Operation
Facts: Farmer owned a 1,000 acre farm with a 500 head cattle
feeding operation with buildings constructed in the 1970s. Farmer
received an offer to sell the cattle feeding operation and surrounding
160 acres for $1,200,000. Farmer utilized an exchange accommodator to
acquire a 160 acre tract worth $800,000, closer to his other land
holdings, and construct a new cattle feeding operation, including
buildings and grain storage, with a completed improvement value of
$600,000. Upon completion of the improvements, the exchange
accommodator transferred the $1,400,000 improved property and
surrounding acres to farmer, completing the like-kind exchange.
Impact: Section 1031 allowed the farmer to exchange into land and
newly constructed improvements so that he could continue farming
operations in a modern and more efficient facility without eroding his
investment through capital gains and recapture tax.
Conclusion: Like-kind exchanges provide maximum flexibility to
taxpayers, and often result in increased capital investment.
Construction of the new improvements created jobs and a stream of
economic activity for machinery, equipment, and building component
suppliers.
7. Conservation Conveyance--Watershed Improvement
Facts: Water quality issues have been going on for some time along
the Mississippi River. Nutrient discharge from agricultural watersheds
in Iowa and other states along the Mississippi watershed has resulted
in a large dead zone in the Gulf of Mexico. This is a major concern for
the EPA, USDA, state agencies and farm groups. The State of Iowa
implemented a Nutrient Reduction Strategy to make improvements. In
response to issues like this, the Iowa Department of Natural Resources
(IDNR), the Natural Resources Conservation Service and other private
and public organizations have implemented programs to acquire permanent
conservation easements to take environmentally sensitive farm fields
out of production, restore wetlands, install buffer strips, stabilize
highly erodible acres and otherwise restore water quality to waterways
in Iowa and other states that feed the Mississippi River.
Farmer owned 80 acres of environmentally sensitive converted
wetlands that had been row cropped. A watershed improvement district
purchased a permanent conservation easement from farmer whereby the
land would be restored to wetlands toward the end goal of improving
downstream water quality. Farmer used the sale proceeds to exchange
into non-environmentally sensitive crop land.
Impact: Local concerns for drinking water, healthy fish and marine
habitat, flooding impacts, and loss of recreational value are all
downstream challenges that benefit from upstream solutions within
watersheds. Section 1031 facilitated and promoted the farmer's
participation in the conservation program and allowed an exchange into
less environmentally sensitive acres, all while preserving his asset
and earning base.
Conclusion: Like-kind exchanges incentivize participation in
conservation programs designed to improve water quality, reduce soil
erosion and bolster wildlife habitat.
8. Conservation Easement--Grazing Association and Public Recreational
Benefit
Facts: A western grazing association, organized as a C corporation,
could utilize additional land to enhance its operations. However, the
dozen+ individual members lacked sufficient acquisition capital and did
not want to encumber the association's assets or their own assets with
additional debt. The USDA Natural Resources Conservation Service (NRCS)
had monies available under a Grasslands Reserve Program to preserve
real property in the area for wildlife, fisheries, public access, etc.
The association conveyed a permanent conservation easement to the NRCS
and used the proceeds to exchange into a number of adjacent properties
that enhanced the grazing operations of the association and its
members.
Impact: The members would not have undertaken this transaction if
it had triggered a double taxable event to them and the association. In
addition to the benefits to the association, the government and the
general public now enjoy permanent access to portions of association
property for fishing, hunting and other recreational pursuits that they
would not have had, but for the easement and Section 1031.
Conclusion: Like-kind exchanges make the economics work to
encourage participation in conservation programs that preserve our
environment and create recreational spaces that benefit all Americans.
9. Upgrading Agricultural Equipment
Facts: Farmer acquired additional acres necessitating the purchase
of a larger combine valued at $550,000. Farmer traded in his fully
depreciated combine and was given a $250,000 trade-in credit toward the
purchase.
Impact: A trade-in is a simultaneous like-kind exchange that
enabled the farmer to upgrade his equipment without penalty or any
reduction in purchasing power. Without a 1031 tax deferral, the
farmer's net (after tax) capital available for reinvestment into the
replacement combine would have been reduced by up to $100,000 (assuming
a combined Federal/state tax rate of 40% applied against the $250,000
sale price of the fully depreciated equipment).
Note that the $250,000 recapture gain (attributable to the trade-in
credit) is rolled into the new combine, and cannot be depreciated.
Under present MACRS depreciation rules, the replacement equipment's
remaining $300,000 taxable basis would be depreciated over 7 years.
Like-kind exchanges are essentially revenue neutral over the tax life
of depreciable assets because the gain deferred is directly offset by a
reduction in future depreciation deductions available for assets
acquired through an exchange. Nevertheless, the taxpayer benefits from
spreading out depreciation and softening the impact of recapture.
Conclusion: Like-kind exchanges of agricultural equipment encourage
investment by farmers and ranchers in new assets that are more
technologically advanced, efficient or better suited to their
operations.
______
Submitted Letter by Roger Johnson, President, National Farmers Union
April 5, 2017
Hon. K. Michael Conaway, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Dear Chairman Conaway and Ranking Member Peterson:
Thank you for holding today's hearing entitled, Agriculture and Tax
Reform: Opportunities for Rural America. As you are well aware, the
farm economy is continuing to struggle as a result of low commodity
prices, record harvests, and a strong U.S. dollar. Forecasts indicate
that low prices will persist. In light of such challenges, National
Farmers Union (NFU) believes we must pro[cee]d cautiously regarding
changes that could sink an already fragile economy deeper into
instability.
Like so many other organizations, NFU believes that tax reform is a
necessary task for this Congress because the Tax Code has become far
too complex and burdensome. NFU supports a simplified Tax Code and a
more progressive tax structure.
Our members support increases to the dollar value of the gift tax
to $25,000. We also support a range of tax credits including bonus
depreciation, section 179, the investment and production tax credit,
interest deductions, charitable deductions and the use of stepped-up
basis. Our members are supportive of holding companies accountable for
their full tax liabilities, especially those that use avoidance
measures such as inversions, off-shoring, and highly aggressive
accounting provisions.
NFU would like to distance itself from the stated position taken
last week by a coalition of agricultural groups calling for the
elimination of the estate tax. NFU supports increasing the estate tax
limit to $10 and $20 million for individuals and couples respectively.
However, the elimination of the tax altogether poses significant
problems. The revenue it raises, an estimated $300 million over 10
years, would no longer flow to the treasury, even as our nation
continues to face significant deficits.
The number of operations impacted by the estate tax is grossly
overstated. The number of operations impacted varies from year to year,
but it certainly falls below less than one percent. According to USDA,
using simulations based on farm-level data from the Agricultural
Resource Management Survey in 2014, for the 2015 tax year, it was
estimated that only three percent of farm estates would be required to
file an estate tax return, with about 0.8 percent owing any Federal
estate tax. It is important for the Committee to remember that this
data came at the height of farm values. Given the current economy, we
can expect the number of farms impacted to be even lower.
Agriculture enjoys significant flexibility under the estate tax.
Special use valuation, stepped-up basis, and a variety of other tools
can be utilized to minimize tax liability. In fact, special use
exemptions can total over a million dollars per individual and
additional deductions from farm assets can send the exemptions even
higher. Furthermore, the Tax Policy Center estimates, those who are
required to pay the tax usually pay an average of roughly five percent,
well below the 40 percent figure in statute. Abolishing the estate tax
would ensure the accumulation of dynastic level wealth. Such a concept
flies in the face of the very bedrock of our nation's founding.
NFU is also concerned over the current tax reform proposals being
advanced in the House of Representatives. The Blueprint, released
during the previous Congress by Chairman Brady, has a number of
concerning components. While we understand that the border adjustment
tax is a necessary revenue component of the plan, we are concerned over
both the novelty of the approach and the negative impact it could have
on agricultural trade.
The tax would likely result in appreciation of the value of the
dollar, making American goods, ag exports in particular, less
competitive in the international market. This could drive up already
high grain stocks and reduce prices paid to producers. A significant
portion of the U.S. manufacturing base imports raw materials from
outside the U.S. Since there would be a 20 percent tax on these raw
materials, the costs of finished products would also increase. Such
goods could include tractors and other farm machinery and could easily
extend to products like fertilizer, chemicals and petroleum products.
Since the tax favors domestic products over imported products, it
is widely expected that such a tax would be challenged through the
World Trade Organization (WTO) and also invite international
retaliation, for which producers are particularly vulnerable. Last, the
tax, indirectly a subsidy to exports in the form of a negative tax,
would not directly benefit agricultural producers, since it is rarely
the farmers doing the exporting. Many agricultural exporters also would
not have sufficient non-export related taxable income to receive much
benefit from the adjustment tax.
While NFU members appreciate the goal of lower rates under the
Blueprint, we believe the proposal would end up increasing effective
rates for producers. The Blueprint makes significant changes in the tax
framework that would have negative impacts on businesses that carry
significant debt loads. These provisions would especially hurt
beginning farmers and ranchers. The immediate write-off of all
investments does little good for producers who already utilize section
179, currently capped at $500,000. Unlimited expensing has little value
to most farmers.
The removal of net interest expensing from the Tax Code would have
a significant negative impact on producers today, but also even more so
in the future if interest rates increase as expected. Removing the
carryback allowance for net operating losses would also have negative
impacts on producers. While unlimited carry forward would be meaningful
under the Blueprint, it does not offset the negatives of eliminating
carryback. Overall, itemizers fare worse under the Blueprint.
NFU recognizes the challenging task tax reform represents. We
appreciate that the House Ways and Means Committee is working to carry
out needed reforms. Our members stand in opposition to this plan. As
your Committee examines the impact of reform, we hope you will work to
remedy the problems identified above. We greatly appreciate your
attention in this matter.
Sincerely,
Roger Johnson,
President, National Farmers Union.
______
Submitted Letter by Like-Kind Exchange Stakeholder Coalition
April 7, 2017
Hon. K. Michael Conaway, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Dear Chairman Conaway and Ranking Member Peterson:
In connection with the House Agriculture Committee's recent hearing
on Agriculture and Tax Reform: Opportunities for Rural America, we are
submitting as a statement for the record the attached letter urging you
to preserve the current availability of like-kind exchange treatment as
part of any business tax reform. Thank you for your consideration and
your leadership on these important issues.
Sincerely,
The Like-Kind Exchange Stakeholder Coalition.
attachment
November 29, 2016
Jim Carter,
Tax Policy Lead,
Presidential Transition,
Washington, D.C.
Dear Mr. Carter:
As you consider ways to create jobs, grow the economy, and raise
wages through tax reform, we strongly urge that current law be retained
regarding like-kind exchanges under section 1031 of the Internal
Revenue Code (``Code''). We further encourage retention of the current
unlimited amount of gain deferral.
Like-kind exchanges are integral to the efficient operation and
ongoing vitality of thousands of American businesses, which in turn
strengthen the U.S. economy and create jobs. Like-kind exchanges allow
taxpayers to exchange their property for more productive like-kind
property, to diversify or consolidate holdings, and to transition to
meet changing business needs. Specifically, section 1031 provides that
taxpayers do not immediately recognize a gain or loss when they
exchange assets for ``like-kind'' property that will be used in their
trade or business. They do immediately recognize gain, however, to the
extent that cash or other ``boot'' is received. Importantly, like-kind
exchanges are similar to other non-recognition and tax deferral
provisions in the Code because they result in no change to the economic
position of the taxpayer.
Since 1921, like-kind exchanges have encouraged capital investment
in the U.S. by allowing funds to be reinvested back into the
enterprise, which is the very reason section 1031 was enacted in the
first place. This continuity of investment not only benefits the
companies making the like-kind exchanges, but also suppliers,
manufacturers, and others facilitating them. Like-kind exchanges ensure
both the best use of real estate and a new and used personal property
market that significantly benefits start-ups and small businesses.
Eliminating like-kind exchanges or restricting their use would have a
contraction effect on our economy by increasing the cost of capital,
slowing the rate of investment, increasing asset holding periods and
reducing transactional activity.
A 2015 macroeconomic analysis by Ernst & Young found that either
repeal or limitation of like-kind exchanges could lead to a decline in
U.S. GDP of up to $13.1 billion annually.\1\ The Ernst & Young study
quantified the benefit of like-kind exchanges to the U.S. economy by
recognizing that the exchange transaction is a catalyst for a broad
stream of economic activity involving businesses and service providers
that are ancillary to the exchange transaction, such as brokers,
appraisers, insurers, lenders, contractors, manufacturers, etc. A 2016
report by the Tax Foundation estimated even greater economic
contraction--a loss of 0.10% of GDP, equivalent to $18 billion
annually.\2\
---------------------------------------------------------------------------
\1\ Economic Impact of Repealing Like-Kind Exchange Rules, Ernst &
Young (March 2015, Revised November 2015), at (iii), available at
http://www.1031taxreform.com/wp-content/uploads/Ling-Petrova-Economic-
Impact-of-Repealing-or-Limiting-Section-1031-in-Real-Estate.pdf.
\2\ Options for Reforming America's Tax Code, Tax Foundation (June
2016) at p. 79, available at http://taxfoundation.org/article/options-
reforming-americas-tax-code.
---------------------------------------------------------------------------
Companies in a wide range of industries, business structures, and
sizes rely on the like-kind exchange provision of the Code. These
businesses--which include real estate, construction, agricultural,
transportation, farm/heavy equipment/vehicle rental, leasing and
manufacturing--provide essential products and services to U.S.
consumers and are an integral part of our economy.
A microeconomic study by researchers at the University of Florida
and Syracuse University, focused on commercial real estate, supports
that without like-kind exchanges, businesses and entrepreneurs would
have less incentive and ability to make real estate and other capital
investments.\3\ The immediate recognition of a gain upon the
disposition of property being replaced would impair cash-flow and could
make it uneconomical to replace that asset. This study further found
that taxpayers engaged in a like-kind exchange make significantly
greater investments in replacement property than non-exchanging buyers.
---------------------------------------------------------------------------
\3\ David Ling and Milena Petrova, The Economic Impact of Repealing
or Limiting Section 1031 Like-Kind Exchanges in Real Estate (March
2015, revised June 2015), at 5, available at http://
www.1031taxreform.com/wpcontent/uploads/Ling-Petrova-Economic-Impact-
of-Repealing-or-Limiting-Section-1031-in-Real-Estate.pdf.
---------------------------------------------------------------------------
Both studies support that jobs are created through the greater
investment, capital expenditures and transactional velocity that are
associated with exchange properties. A $1 million limitation of gain
deferral per year, as proposed by the Administration,\4\ would be
particularly harmful to the economic stream generated by like-kind
exchanges of commercial real estate, agricultural land, and vehicle/
equipment leasing. These properties and businesses generate substantial
gains due to the size and value of the properties or the volume of
depreciated assets that are exchanged. A limitation on deferral would
have the same negative impacts as repeal of section 1031 on these
larger exchanges. Transfers of large shopping centers, office
complexes, multifamily properties or hotel properties generate economic
activity and taxable revenue for architects, brokers, leasing agents,
contractors, decorators, suppliers, attorneys, accountants, title and
property/casualty insurers, marketing agents, appraisers, surveyors,
lenders, exchange facilitators and more. Similarly, high volume
equipment rental and leasing provides jobs for rental and leasing
agents, dealers, manufacturers, after-market outfitters, banks,
servicing agents, and provides inventories of affordable used assets
for small businesses and taxpayers of modest means. Turnover of assets
is key to all of this economic activity.
---------------------------------------------------------------------------
\4\ General Explanations of the Administration's Fiscal Year 2017
Revenue Proposals, at 107, available at https://www.treasury.gov/
resource-center/tax-policy/Documents/General-Explanations-FY2017.pdf.
---------------------------------------------------------------------------
In summary, there is strong economic rationale, supported by recent
analytical research, for the like-kind exchange provision's nearly 100
year existence in the Code. Limitation or repeal of section 1031 would
deter and, in many cases, prohibit continued and new real estate and
capital investment. These adverse effects on the U.S. economy would
likely not be offset by lower tax rates. Finally, like-kind exchanges
promote uniformly agreed upon tax reform goals such as economic growth,
job creation and increased competitiveness.
Thank you for your consideration of this important matter.
Sincerely,
Air Conditioning Contractors of International Council of Shopping
America; Centers;
American Car Rental Association; NAIOP, the Commercial Real Estate
Development Association;
American Rental Association; National Apartment Association;
American Seniors Housing National Association of Home
Association; Builders;
American Truck Dealers; National Association of Real Estate
Investment Trusts;
American Trucking Associations; National Association of REALTORS;
Associated Equipment Distributors; National Automobile Dealers
Association;
Associated General Contractors of National Business Aviation
America; Association;
Avis Budget Group, Inc.; National Multifamily Housing
Council;
Building Owners and Managers National Ready Mixed Concrete
Association (BOMA) International; Association;
C.R. England, Inc.; National Stone, Sand and Gravel
Association;
Equipment Leasing and Finance Truck Renting and Leasing
Association; Association.
Federation of Exchange
Accommodators;
______
Submitted Statement by Neil E. Harl, Ph.D., Charles F. Curtiss
Distinguished Professor and Professor Emeritus of Economics,
Department of Economics, Iowa State University
First, I want to thank you, The House of Representatives
Agriculture Committee, for the opportunity to provide some ideas on
taxation and tax policy. My apologies for not being able to be present
in Washington on March 15. My wife, Darlene, is suffering from a
neurological malady that no one seems to be able to diagnose but her
condition requires 24-hour care and I am the caregiver. In all of the
years I have been asked to testify before Congressional Committees,
this is the first occasion in which I could not be present.
I am convinced that we are facing perhaps the most important issues
in the agricultural sector in recent times, at least comparing it to
the past half century, perhaps the most important since the 1930's. I
am reluctant to share my age but I can recall well the discussions in
1936, growing up on a rented farm in Iowa.
The political, economic and social problems we face today are
daunting. I have selected seven areas for commentary.
A Rational Fiscal and Monetary Policy
Although fiscal and monetary policy does not embrace all of
taxation, the policies of the 1970s demonstrated how disruptive an
irrational fiscal and monetary policy can be to the agricultural
sector. In Chapter 10 of my book, The Farm Debt Crisis of the 1980s, I
list the 12 lessons we should have learned from that traumatic decade.
My hope would be that we not ignore the lessons learned as we launch
what may be a period of great change in economic and tax policies as
well as fiscal and monetary policies. In many ways, this area of
governmental involvement may be the linchpin of planning for an
economically healthy agricultural sector or a time of experimentation
with uncertain outcomes.
Federal Estate Tax Policy
Over the past half century, the Congress has attempted,
unsuccessfully it turned out, to eliminate the Federal estate tax. The
efforts in 1976 and again in 2001 were rejected (in 1980 for the 1976
attempt and 2010 for the 2001 move) although the support for repeal of
the Federal estate tax has continued. In my opinion, it would be a
great mistake to repeal the tax.
First, it is widely stated that the Federal estate tax is an
obstacle for farming and ranching operations. I disagree. As I have
been quoted fairly widely, in 50 some years of working in this area of
taxation I have never seen a farm or ranch operation that had to be
sold to pay Federal estate tax. The latest quote was several days ago
in the London Financial Times.
At present, 2017, a decedent is allowed to pass $5,490,000 in
property value without triggering Federal estate tax and the spouse is
allowed the same amount for a total of $10,980,000. That figure is
inflation adjusted. Even if the spouse without that much property dies
first, the surviving spouse under the concept of ``portability'' can
utilize the remaining allowance of the deceased spouse. Moreover, since
1976 eligible property meeting the requirements for ``special
valuation'' is eligible for an additional amount (currently $1,120,000)
which is also inflation adjusted. That provision requires that the farm
remain in the family for 10 years at least and be under a share rent
lease or be an operating farm or ranch.
The IRS data, published annually, do not provide data for decedents
dying owning some farm property who were actively farming but it is
clear that those dying whose estates reported some farm property are
mostly in the upper categories of size of estate. It appears to be
clear that only a small percentage of estates for active farmers (less
than one percent) actually pay Federal estate tax.
However, many publications, including farm publications, report
that farmers and ranchers support repeal. In reality, farmers and
ranchers are being ``used'' to support repeal for the upper echelons of
estates because of the higher standing, publicly, of farmers and
ranchers compared with multi-billionaires. This aspect of the matter
was discussed widely in several publications including The London
Financial Times in recent weeks.
There is another dimension to the Federal estate tax issue. The
unsuccessful efforts to repeal the Federal estate tax in recent years
have, rather quietly, admitted that part of the strategy is to pay for
the repeal, in part at least, from reducing or eliminating the new
income tax basis at death. For many years, most assets held at death
have received a new income tax basis equal to the fair market value at
death. To the extent that occurs, the gain in the eligible assets takes
on an income tax basis equal to the fair market value at death. This
feature of tax policy means that virtually all farm and ranch estates
end up with no gain on their assets. This is enormously important and
benefits virtually every decedent and the heirs. Thus, the irony is
that while nearly all deceased farmers and ranchers do not pay Federal
estate tax, they would all lose to the extent the ``new basis at
death'' is lost. That feature of tax policy seems to lack
understanding. Another aspect of the loss of ``new basis at death'' is
that over time, with assets at death not getting a new basis, the
transferability becomes increasingly limited with the heirs unwilling
to pick up the income tax if and when the assets are sold. The result,
without much doubt, is expected to be that economic growth would be
reduced. For that reason, it is my belief, held strongly, that it is in
the public interest for--(1) the ``new basis at death'' to be continued
for public policy reasons and (2) an incentive is provided for heirs to
transfer assets ``to the highest and best use'' which encourages
economic growth over time.
Finally, the Federal estate tax, admittedly, produces a modest
revenue stream but it is significant and a way for very wealthy
decedents to contribute to the public good.
Post Death Discrimination Against Farm Assets
For more than 40 years, an Internal Revenue ruling (Rev. Rul. 75-
361, 1975-2 C.B. 344), has discriminated against livestock classified
as trade or business livestock sold after death. The key statute
(I.R.C. 1223(9)) refers to the period to be eligible for long-term
capital gain in the period after death as referring to property held
for ``. . . more than one year.'' As is widely known the statute is
referring to property used in a trade or business, and thus eligible
for long-term capital gain and ordinary loss treatment. That period is
24 months or more for cattle and horses and, for other livestock, 12
months or more. I.R.C. 1231(b)(3). That rules out the special
treatment assuring long-term capital gain treatment for the first 12
months (or 24 months) for the animals sold after death.
IRS published Rev. Rul. 75-361, 1975-2 C.B. 344, making that very
point and confirming the different treatment for trade or business
livestock. The facts of that ruling were that cattle and other
livestock acquired from the estate produce ordinary income on sale. The
ruling points out that no exception was ever made in the statute for
livestock used in a trade or business with specified holding periods of
12 or 24 months. For animals not held for draft dairy, breeding or
sporting purposes, the animals have a one year holding period as a
capital asset rather than a ``trade or business'' asset and would come
within the statutory rule of an automatic more-than-one-year holding
period at death.
It seems inequitable for the trade or business livestock to be
treated less favorably than livestock categorized as capital assets
(such as held for entertainment, research or other non-business use)
which come within the automatic ``more-than-one-year'' holding period
at death.
Mergers and Acquisitions
From a policy perspective, we need to go back to the basics of
antitrust, to a period more than a century ago, when the country was
expressing concern about anti-competitive practices in steel, oil, rail
transportation and even in agriculture. Indeed, the 1888 report to the
United States Senate on anti-competitive practices contributed
significantly to enactment of the Sherman Antitrust Act of 1890, often
referred to as the ``charter of economic freedom.''
In a nutshell, the three most important features of a market-
oriented economy, are competition, competition and competition. We have
seen the growth of rivalry in some markets but rivalry is not
competition. The most critical aspects of our price and market-oriented
economy are free, open and competitive markets.
In this country, in recent years, the emphasis has been on
protecting the consumer. If a merger did not adversely affect
consumers, the problem received little attention. I argued in a
teleconference about a decade or more ago with Department of Justice
lawyers and economists, about the shortcomings of that internal policy,
urging a parallel emphasis on the impact of potentially competitive
practices on producers. I got nowhere with that argument. Quite
obviously, farming has so many participants that no single farmer (or
rancher) can affect price with their output decisions. If one of the
objectives is to foster and encourage a sector of independent
entrepreneurs, rather than serfs, it is important to look at the impact
on producers.
In recent years, my areas of principal concerns have been centered
in six areas--(1) meat packing, including captive supplies, by highly
concentrated meat packers; (2) seeds and chemicals; (3) grain handling
and shipping; (4) farm equipment manufacturing; (5) fertilizer
production and distribution; and (6) food retailing. However, my
greatest concern in recent years has been the breathtaking increase in
concentration (and influence over competitors) in the areas of seeds
and chemicals. One of the major concerns has been the absence of
generics at the expiration of patents (which now dominate the seed
business). The patent system represents a willingness of the American
people to accept a monopoly position over new and novel developments
for a limited term but not forever.
In my view when the combined market shares reach 50 percent, a
merger or acquisition should be deemed out of the question. This is a
long-term issue and one of the more important in our portfolio.
The ``Small Partnership'' Exception
In my opinion, one of the key issues in the taxation arena is
whether we are capable of simplifying the tax system. In 1967, I was
asked to join a small group which was convened by the Department of the
Treasury to advise the Department of how to address ``tax sheltering''
which was sweeping the agricultural sector. The lure of investment tax
credit, fast depreciation and other more subtle practices were coming
to influence economic practices, especially in livestock. Our group
made several recommendations which were mostly enacted in 1969, 1976,
1981 and 1986. However, the tax committees (and IRS) in the 1970s
reached the conclusion that the villain was partnerships, principally
limited partnerships. Those organizational structures were present in
many of the tax shelters. The outcome was that Congress became
convinced that it was necessary to ``get tough'' with partnership
taxation and weed out the unacceptable behaviors. However, a group of
Senators and Members of the House of Representatives concluded that the
``get tough'' policy with partnerships would make life very difficult
for small partnerships. That group convinced the Congress to accept an
amendment to simplify tax filing for small businesses.
The amendment passed and was part of the Tax Equity and Fiscal
Responsibility Act of 1982. The nine-line amendment stated, in I.R.C.
6231(a)(1)(B)(i)--
``The term `partnership' shall not include any partnership
having 10 or fewer partners each of whom is an individual
(other than a nonresident alien), a C corporation, or an estate
of a deceased partner.''
Essentially, it meant that a ``small partnership'' did not have to file
a Form 1065 and the income, losses and credits simply flowed through to
the taxpayers' Form 1040s. Moreover, the resulting entity avoided the
highly complicated restrictions imposed on regular partnerships. It
turned out that it was undoubtedly the most significant tax
simplification move in decades.
Over the years, I covered the subject in what eventually became my
669 page seminar manual in about 3,400 seminars. I detected rumblings
of resistance among some practitioners, mainly CPAs, often citing that
it adversely affected ``their bottom line.'' My response often was ``a
professional in practice should focus attention on what is in the best
interests of the client, not on what is in the best interests of the
practitioner.''
However, a group of unhappy tax practitioners--principally in the
Pacific Northwest and Midwest-managed to convince a Member of the House
of Representatives to push through an amendment to the Bipartisan
Budget Act of 2015, carefully camouflaged, repealing the ``small
partnership'' exception effective after December 31, 2017. There were
no hearings, no warnings of what was being plotted and no hint of the
fact that it would eliminate the most significant tax simplification
move in decades.
The Joint Committee on Taxation proved to be the barrier to getting
the 2015 amendment eliminated. The staff insisted all last year that
``there is no such thing as a small partnership.'' We set out to prove
that there was such a thing with an article in Tax Notes, page 1015 of
the August 15, 2016 issue; the fact that IRS has embraced the small
partnership with IRS Publication 541, January 2016, which details the
opportunities to make use of the ``small partnership'' exception, at
page 13; by publishing Revenue Procedure 1984-35, 1984-1 C.B. 509; by
reproducing the content of that Revenue Procedure in the I.R. Manual,
I.R.M. 20.1.2.3.3.1, and by litigating in more than 20 cases involving
various issues with the ``small partnership.''
It is our belief that if the ``small partnership'' is reinstated,
it will become the dominant entity for eligible small partnerships.
Reinstatement would not affect Federal revenues (the tax rates are the
same to file a Form 1040 with the information as to file a complex Form
1065). At a time when many farm and ranch operations are struggling
financially because of the low market prices for many of the
commodities, the savings would be welcomed. The going rate for filing a
complete Form 1065 varies but runs in the vicinity of $2,000 to $2,500
or more.
What about a ``flat tax''?
The idea of a ``flat tax'' has been around for nearly 30 years. A
colleague and I wrote an article evaluating that possibility. Our
conclusions were that the revenue would fall well short of the revenue
needed to maintain programs at the level the public has been
accustomed, it would impose a heavy tax burden on lower tax bracket
taxpayers and it would distort economic decision making with full
deductibility of expenditures, at least for many investments. Our
conclusion was that the idea did not deserve serious attention.
Repealing the Rule Against Perpetuities
Finally . . . a word or two about an ancient concept (that is, it
is ancient to many of us) that had its origins in the Duke of Norfolk's
Case in the late 17th Century in England. The case involved
disagreements among the heirs of the Duke of Norfolk over the propriety
of leaving property in successive life estates. The court agreed that
it was wrong to tie up property beyond the lives of persons living at
the time the property was last conveyed, although the exact time beyond
which conveyances were nullified was not determined until roughly 150
years later. As a practical matter, the Rule (as it is known) places
limits on how long property can be held in trust. Stated simply,
property generally could not be held in trust beyond the lifetimes of a
designated class of individuals plus 21 more years. As a practical
matter, the Rule allows property ownership to be tied up for 100 to 125
years
Until about 40 years ago, each of the states in this country had
enacted language embodying the Rule. After South Dakota, under the
leadership of their then Governor Janklow broke ranks and repealed the
Rule in that state, 30 more states have acted to repeal or modify the
Rule. However, 19 states have held out with those states believing that
it is not in the public interest to eliminate the Rule and allow
property ownership to be tied up forever.
Professor Lewis Simes, a well-known legal scholar articulated two
reasons for the Rule in contemporary society--(1) first, the Rule
strikes a fair balance between the desires of the present generation,
and similar desires of succeeding generations, to do what they wish
with the property which they enjoy; and (2) a second and even more
important reason for the Rule is that it is socially desirable that the
wealth of the world be controlled by its living members and not by the
dead. To those two I have added a third--it is an article of faith that
economic growth is maximized if resources at our disposal are subject
to the forces and pressures of the market. Prices emanating from free,
open and competitive markets are the best way to allocate resources and
distribute income.
However, it is a bit sobering to envision a world economy in a
couple of hundred years where the ownership of property is held by a
bunch of trusts physically located half a world away with those not
benefitting from ancestors who left property in trust forever unable to
acquire land to farm, houses in which to live or real estate for other
ventures except as tenants.
Fortunately, my wife and I live in a state that has three times
since 1999 voted to retain the Rule. In my view, our generation
inherited the best economic system and the best legal system in the
world. To repeal the Rule would be a step backward. The Administration
in 2011 took steps to place a limit on how long property can be held in
trust. We would be wise to review carefully whether that limit should
be imposed nationally.
Thank you!
Neil E. Harl.
______
Submitted Statement by Dave Tenny, President and Chief Executive
Officer, National Alliance of Forest Owners
I'd like to take this opportunity to mention the critical role that
private working forests play in our rural economies. Many rural
communities are located in heavily forested states where the forest
products sector suffered historic economic setbacks during the Great
Recession. In these communities forestry and forest products
manufacturing have historically been a primary source of good paying
family-waged jobs that provide lumber, paper, packaging, energy and
more than 5,000 other economically valuable products.
The economic importance of these forests is evident from the 2.4
million domestic jobs supported and $280 billion in value generated
across a supply chain that includes foresters, loggers, truckers, mill
workers, equipment suppliers, service providers, and many others. Most
working forests--over seventy percent nationally--are privately owned
by families, small and large businesses and an increasingly broad array
of Americans who invest in forest ownership through investment vehicles
such as pension and mutual funds. The economic value derived from
working forests is directly connected to a 50% increase in overall tree
volume domestically over the past 60 years--because markets for forest
products provide an incentive to keep working forests as forests. In
turn, increased volume in forest products has enabled the United States
to meet much of our domestic demand for wood products.
The economic growth and opportunity fostered by private working
forests is rooted in tax policies that recognize the unique, capital-
intensive, long-term nature of timberland stewardship. These tax
policies encourage sound management practices and investments that keep
forestlands and the economy they support productive for generations to
come. By ensuring tax reform recognizes the policies that make working
forests strong, we secure a bright future for the rural families,
individuals, and communities that rely on them.
Timber is an attractive investment opportunity featuring a non-
volatile asset, a hedge against inflation, and access to significant
long-term yield. Unlike stocks, investments in forests provide unique
built-in, biologic growth that is immune from market volatility. That
is one reason why public and private pension funds maintain sizable
investments in timberlands through timberland investment management
organizations (TIMOs) and publicly traded timberland real estate
investment trusts (REITs). Working forests are a part of most
Americans' retirement portfolios.
We urge Congress to recognize the long-term capital investments and
risks associated with forest ownership and management by ensuring the
Federal Tax Code continues to encourage long-term investment in private
forests. Provisions that ensure the continued capital gains treatment
of timber revenue, the deductibility of timber growing and
reforestation costs, and the treatment of timberland as real property
are critical to the health of working forests and rural communities.
______
Submitted Joint Letter by American Farm Bureau Federation
March 29, 2017
Hon. Kevin Brady,
Chairman,
House Committee on Ways and Means,
Washington, D.C.;
Hon. Richard Neal,
Ranking Minority Member,
House Committee on Ways and Means,
Washington, D.C.
Dear Chairman Brady and Ranking Member Neal:
On behalf of our nation's family farmers and ranchers, we come
together now to ask your support for including permanent repeal of the
estate tax in any tax reform legislation moving through Congress this
year. In addition, we ask your help to make sure that the benefits of
repeal are not eroded by the elimination of or restrictions to the use
of the stepped-up basis.
Family farmers and ranchers are not only the caretakers of our
nation's rural lands but they are also small businesses. The estate tax
is especially damaging to agriculture because we are a land-based,
capital-intensive industry with few options for paying estate taxes
when they come due. Unfortunately, all too often at the time of death,
farming and ranching families are forced to sell off land, farm
equipment, parts of the operation or take out loans to pay off tax
liabilities and attorney's fees.
As you know, the American Taxpayer Relief Act of 2012 (ATRA)
permanently extended the estate tax exemption level to $5 million per
person/$10 million per couple indexed for inflation, and maintained
stepped up basis. While we are grateful for the relief provided by the
ATRA, the current state of our economy, combined with the uncertain
nature of our business has left many agricultural producers guessing
about their ability to plan for estate tax liabilities and unable to
make prudent business decisions. Until the estate tax is fully repealed
it will continue to threaten the economic viability of family farms and
ranches, as well as the rural communities and businesses that
agriculture supports.
In addition to full repeal of the estate tax, we believe it is
equally as important for Congress to preserve policies which help keep
farm businesses intact and families in agriculture. As such, tax reform
must maintain stepped-up basis, which limits the amount of property
value appreciation that is subject to capital gains taxes if the
inherited assets are sold. Because farmland typically is held by one
owner for several decades, setting the basis on the value of the farm
on the date of the owner's death under stepped-up basis is an important
tax provision for surviving family members.
U.S. farmers and ranchers understand and appreciate the role of
taxes in maintaining and improving our nation; however, the most
effective Tax Code is a fair one. For this reason, we respectfully
request that any tax reform legislation considered in Congress will
strengthen the business climate for farm and ranch families while
ensuring agricultural businesses can be passed to future generations.
Thank you for your continued efforts in support of our nation's
agricultural producers. We look forward to working with you on this
very important issue.
Respectfully,
Agricultural & Food Transporters National Renderers Association
Conference
Agricultural Retailers Association National Sorghum Producers
American Farm Bureau Federation National Turkey Federation
American Sheep Industry Association Panhandle Peanut Growers
Association
American Soybean Association South East Dairy Farmers
Association
American Sugarbeet Growers Southwest Council of Agribusiness
Association
Livestock Marketing Association U.S. Apple Association
National Association of State U.S. Canola Association
Departments of Agriculture
National Barley Growers Association U.S. Rice Producers Association
National Cattlemen's Beef U.S. Sweet Potato Council
Association
National Cotton Council United Egg Producers
National Council of Farmer United Fresh Produce Association
Cooperatives
National Milk Producers Federation USA Rice Federation
National Peach Council Western Growers
National Pork Producers Council Western Peanut Growers Association
National Potato Council Western United Dairymen
______
Submitted Statement by American Forest Foundation
Federal tax policy can have a significant impact on the nation's
forests and rural economies. Most of America's forests are owned
privately, not by government or big corporations. The 22 million family
forest owners accounting for nearly 282 million acres of forestland
rely on their ability to invest in their land, finance the stewardship
that's needed, and afford the taxes, in order to keep the land as a
forest. These family woodlands are not only important for the clean
water and air, wildlife habitat, and recreational opportunities--they
support more than 2.4 million jobs in rural America. These lands supply
a majority of the wood consumed in forest products manufacturing too.
Currently--there are a number of tax provisions that are important
to family woodland owners:
Capital Gains Treatment of Timber Income: When landowners
harvest timber, a long-term investment often requiring decades
of expense with returns maybe once a generation, they are
currently allowed to treat this income as a capital gain, just
like other long-term investments.
Forest Management and Reforestation[:] Currently landowners
can deduct forest management and reforestation expenses, such
as installing a fire break to reduce wildfire risk, installing
culverts in forest roads to protect streams, paying property
taxes, or replanting trees after harvest. This helps landowners
afford these good land management practices that ultimately
help the economy and the environment.
Estate Tax: This can impact whether a landowner is able to
pass their land on in their family and can also force premature
or unsustainable timber harvesting.
Conservation Easement Tax Deductions: Donors of qualified
conservation easement can take a tax deduction that ultimately
helps keep working lands intact.
These tax provisions are what help landowners continue to invest in
forests and afford the good stewardship that's necessary. We understand
that the tax reform discussion is about streamlining and reducing
complicated tax provisions. Family woodland owners fully support this.
However, we do ask that the unique nature of forestry be taken into
account in these deliberations and that the Tax Code reflect this--
ensuring that landowners just like any long-term investor, can treat
their timber as a capital gain and ensuring landowners can deduct (or
expense) their business/land management related expenses, including
property taxes--so they aren't taxed twice.
______
Submitted Statement by National Council of Farmer Cooperatives
Mr. Chairman, Ranking Member Peterson, and Members of the
Committee, the National Council of Farmer Cooperatives (NCFC)
appreciates the opportunity to submit testimony for the record as part
of the House Agriculture Committee's hearing on agriculture and tax
reform.
NCFC represents the interests of America's farmer-owned
cooperatives. With nearly 3,000 farmer cooperatives across the United
States, the majority of our nation's more than two million farmers and
ranchers belong to one or more farmer co-ops. NCFC members also include
twenty-one state and regional councils of cooperatives.
Farmer-owned cooperatives are central to America's abundant, safe,
and affordable food, feed, fiber, and fuel supply. Through
cooperatives, farmers can better manage risk, strengthen bargaining
power, and improve their income from the marketplace, allowing
individual producers to compete globally in a way that would be
impossible to replicate as individual producers. In short, cooperatives
share the financial value they create with their farmer-owners.
By pooling the buying power of hundreds or thousands of individual
producers, farmer cooperatives are able to supply their members--at a
competitive price--with nearly every input necessary to run a
successful farming operation, including access to a dependable source
of credit. Furthermore, farmer cooperative members can capitalize on
new marketplace opportunities, including value-added processing to meet
changing consumer demand. Cooperatives also create and sustain quality
jobs, businesses, and consumer spending in their local communities.
NCFC supports pro-growth tax reform and wants to work with Congress
to achieve this result. However, certain aspects of tax reform must be
coordinated with the special circumstances of agriculture in general
and cooperatives in particular. We applaud the Committee's invitation
to provide a forum for these important issues.
Farmer cooperatives calculate their taxable income under Subchapter
T of the Internal Revenue Code. Under Subchapter T, earnings from
business conducted with or for a cooperative's members are subject to
single tax treatment as income of farmer members, provided the
cooperative pays or allocates the earnings to its members. If the
earnings are used to support the cooperative's capital funding or other
needs, the earnings are taxed at regular corporate rates when retained
and taxed a second time when distributed to the farmer members.
Additionally, earnings from sources other than business with or for the
cooperative's members are taxed at corporate rates. This method of
taxation has been in use for nearly a century and was codified more
than 50 years ago. NCFC supports the continuation of Subchapter T and
related regulations.
The House GOP Blueprint would reduce the top individual marginal
rate from 39.6 percent to 33 percent, and it would reduce the top pass-
through rate to 25 percent on non-wage income. For cooperatives to
thrive, the Blueprint should provide that patronage distributions from
cooperatives are subject to the 25 percent maximum pass-through rate.
Currently, patronage distributions are subject to individual tax rates,
which max out at 39.6 percent. This is the same rate that currently
applies to pass-through income from partnerships, limited liability
companies and S corporations. If the 25 percent rate is applied to
income from these entities but not cooperatives, the maximum tax rate
on patronage distributions will be 33 percent, placing cooperatives and
their members at a disadvantage. It is essential that the rate on pass-
through income apply to patronage distributions from cooperatives.
NCFC members are also concerned about the Border Adjustability Tax
(``BAT''). The provision would make exports tax-free, a benefit to
exporters. However, farmer cooperatives would need a way to pass that
benefit through to their farmer members who produce the exported goods.
The BAT also would disallow the business expense deduction for imported
goods, resulting in essentially a 20 percent tax on imported goods
(assuming a 20 percent corporate tax rate). For agriculture, a tax on
imported fertilizer, fuel, farm machinery components, and retail goods
would be extremely detrimental.
Tax experts say the BAT should cause a rise in the dollar's value,
which would offset the loss of the deduction for imports by making
imported goods cheaper. However, there is no guarantee on the timing or
extent of the rise in value of the dollar. Also, consideration should
be given to the effects of the strengthening of the dollar, which would
increase costs for U.S. trading partners and likely result in
retaliatory tariffs on farm exports.
The Blueprint also would eliminate the deduction for net interest
expense and would allow for immediate expensing of capital investments,
other than land. In many cases, farmers do not have the resources to
satisfy all of their cooperatives' capital needs. As a result,
cooperatives often rely on debt to finance growth. The repeal of the
deduction for interest on debt would cause harm to farmer cooperatives
and their members by impeding business expansion, new hiring, and
product development. Immediate expensing of capital investments is also
a challenge for farmer cooperatives. By not spreading the cost of an
investment over the life of the asset, the provision will cause net
operating losses that cannot be equitably shared among current and
future members.
Additionally, the Blueprint would repeal Section 199, the Deduction
for Domestic Production Activities Income. The Section 199 deduction
was enacted as a jobs creation measure in The American Jobs Creation
Act of 2004. The deduction applies to proceeds from agricultural or
horticultural products that are manufactured, produced, grown, or
extracted by cooperatives, or that are marketed through cooperatives,
including dairy, grains, fruits, nuts, soybeans, sugar beets, oil and
gas refining, and livestock.
Cooperatives may choose to pass the Section 199 deduction through
to their members or to keep it at the cooperative level, making it
extremely beneficial to both. Section 199 benefits are returned to the
economy through job creation, increased spending on agricultural
production and increased spending in rural communities. Some have
suggested lowering corporate rates to offset the impact of the loss of
the deduction. However, because farmer cooperatives' income is passed
through to farmer members, a corporate rate reduction would not benefit
cooperatives and their members. NCFC opposes the repeal of this
incentive for domestic production.
If tax reform retains the requirement to maintain inventory records
for tax purposes, NCFC supports the continued viability of the last-in,
first-out (LIFO) accounting method. LIFO is a widely accepted
accounting method and is used by some farmer cooperatives. Taxpayers
using LIFO assume for accounting purposes that inventory most recently
acquired is sold first. If LIFO is repealed and replaced with the
first-in, first-out (FIFO) method, farmer cooperatives and other
businesses would be taxed as though they had sold all of their
inventory assets, even though they would have received no cash.
Obtaining the funds necessary to pay the tax on this deemed sale would
cause severe strain on cooperatives' capital budgets. Taxation of LIFO
reserves would be the equivalent of a retroactive tax on the savings of
a cooperative.
NCFC also supports reinstating the alternative fuel mixture credit,
which expired on December 31, 2016. The credit incentivizes use of
propane, a clean-burning, low-carbon, domestic, and economical
alternative to gasoline and diesel.
NCFC thanks this Committee for helping to ensure tax policy
continues to protect and strengthen the ability of farmers and ranchers
to join in cooperative efforts in order to maintain and promote the
economic well-being of farmers, ensure access to competitive markets,
and help capitalize on market opportunities.
______
Submitted Questions
Response from James M. Williamson, Ph.D., Economist, Economic Research
Service, U.S. Department of Agriculture
Questions Submitted by Hon. Stacey E. Plaskett, a Delegate in Congress
from Virgin Islands
Question 1. This Blueprint would provide full expensing for all
capital investments. A farm or business could buy a new product and
instead of writing off the cost over time, it would be immediate.
Authors of the Blueprint argue that this will increase investment and
make businesses more productive. But there are reasons why the Code was
shaped the way that it was. The advantage of having a machine often
occurs over a period of numerous years.
Assuming something like this Blueprint is enacted this session,
what about a farmer who invested last year in a machine with a 10 year
lifespan, expecting they would benefit from the 10 year write off? What
about people operating businesses that do not replace equipment every 2
years, who only buy one line of equipment every 10 years or more? If
they are in a business where it takes a long time to use their product
and they did not plan on making another investment for another decade,
wont they lose out?
Answer. With regard to the Blueprint, it is my understanding that
the business owner/farmer would still be able to write off (deduct) the
cost of the machine over a number of periods (years) if they so choose.
Under current law, a business owner/farmer is not required to elect to
use the Section 179 expense deduction or additional depreciation
deduction (known as ``Bonus Depreciation''). Rather they may elect to
use the standard method for claiming depreciation allowed under
Internal Revenue Code, which is currently known as the Modified
Accelerated Cost Recovery System (``MACRS''). Under MACRS, all assets
are divided into classes which dictate the number of years over which
an asset's cost will be recovered. Each MACRS class has a predetermined
schedule which determines the percentage of the asset's costs which is
depreciated each year.
As well, if a business owner/farmer does elect to use the Section
179 deduction, he or she may elect to use only a portion of the cost of
the machine under the provision, while the remaining cost of the
equipment is depreciated under MACRS for the remaining numbers of years
specified under the rules of the provision.
Under the Blueprint, if the farmer who wishes to spread the
depreciation deduction over multiple years is still able to so--as they
are able to do under current law--then they will not be made worse off.
Question 2. If tax writers change this so that a farmer could be
exempted and claim expensing until the end of the depreciation life if
the investment was already made at the time of enactment, is that going
to cost a lot more money in terms of the bill's price tag?
Answer. I am not able to assess the revenue effects of the proposed
changes. The Joint Committee on Taxation would be able to answer this
question.
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