[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
                            
                            
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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

                              ----------                              
                                                                   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

                              ----------                              


                        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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.

                                  [all]