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Great new tax breaks . . . and pitfalls

As agricultural tax experts dig into a much-criticized fiscal-cliff deal, they're finding plenty that will benefit farmers and ranchers.

Estate planning has more certainty, now that the Taxpayer Relief Act makes the 2012 level of estate tax exemption permanent and indexed for inflation, said David Marrison, an Extension educator who is Ohio State University's Income Tax School interim director.

"Permanent is the big word. That gives people a lot more security when they sit down with their estate planning professional," Marrison told Agriculture.com Tuesday.

As has been widely reported, the tax rate on the portion of an estate that is still taxed goes up from 35% in 2012 to 40% permanently. But the exemption remains at $5 million, indexed for inflation, which made it $5.12 million in 2012. The unused portion of that exemption from gifts and estate taxes also can be transferred to the surviving spouse, putting the maximum potential tax savings at more than $10 million per couple.

You may also be able to enjoy some tax savings while you're still alive if you purchase machinery or make other capital investments in 2013. The Taxpayer Relief Act increases and extends the Section 179 write-off from the $139,000 that most expected for 2012 to the old 2010-2011 level of $500,000 for 2013. And it retroactively reinstates that expense method of depreciation to $500,000 for 2012. Before the fiscal-cliff deal, Section 179 expensing was set to drop to $25,000 for 2013. The new law puts that off for another year, reverting to $25,000 in 2014.

"However, as always, time will tell," Marrison wrote in a summary of the Taxpayer Relief Act coauthored by Chris Bruynis, OSU Extension assistant professor.

"I think this caught most people off guard," Marrison said. Some tax experts had speculated that Section 179 expensing might be bumped up to $250,000 for 2013, he said. Few expected it to be as generous as $500,000.

Their article, posted on the Ohio Ag Manager website, also notes that the bonus depreciation was extended in the last-minute deal.

"This legislation also extended the special 50% special depreciation allowance, also known as bonus depreciation, through the end of 2013. The bonus depreciation provision generally enables businesses to deduct half the cost of qualifying property in the year it is placed in service. Bonus depreciation is now scheduled to be eliminated for the 2014 tax year," says the article, "Taxpayer Relief Act of 2012 -- What Does it Mean to Ohio Farmers?"

Marrison said that many farmers won't be able to take advantage of the increased Section 179 expensing for 2012, since they didn't know in advance that they could rapidly write off such a high level of purchases. A few may, however.

"There's some farms that were using the Section 179, 50% depreciation and just carrying it over" onto a regular depreciation schedule.

There is a potential tax trap to all of this, however.

"There's some day that the bonus depreciation is going to be gone," Marrison said. If it's eliminated (or drastically reduced as planned for 2014), then farmers who have already used rapid depreciation will have little left to offset taxes after a good year.

"When it ends, that means that for that tax year, there's going to be a hit," he said.

So far, the timing has coincided well with high-income years for grain farmers.

The new tax law does raise capital gains rates along with creating a higher maximum individual tax bracket of $39.6%. But both the highest capital gains tax of 20% and the highest tax bracket apply to those with $400,000 in income for single filers and $450,000 for married couples filing jointly.

Marrison points out that there's almost a marriage penalty for high-income taxpayers, since two single individuals living together would not trigger the top rates until their combined income topped $800,000. He has read speculation that this may cause a spike in divorces.

"We're not encouraging farmers to go out and get divorced," he said.

Marrison and others will discuss these and other tax issues in webinars scheduled for January 29 from 9-11 a.m. and February 6, from 7-9 p.m. (Eastern Standard Time). Here's the link.

As Marrison and others point out, more farmers could take a tax hit from a new 3.8% Medicare tax (effective January 1) on passive sources of income. This tax wasn't part of the fiscal-cliff deal. It's one of several taxes passed to help pay for Obamacare. And it applies to a lower level modified adjusted gross income, $250,000 on a joint return.

Partly for that reason, Roger McEowen, director of the Iowa State University Center for Agricultural Law and Taxation, counted the Supreme Court's upholding the tax mandate of Obamacare as one of the Top Ten Agricultural Law Developments of 2012.

The new Medicare tax "includes capital gains, dividends, rents, royalties, and passive K- 1 income. For farmers and ranchers, several things need to be kept in mind. Sales of farm business assets (land and equipment, etc.) will not be subject to the tax if the taxpayer had materially participated in the business for five years in the eight-year period before receipt of Social Security benefits. Cash lease income is passive and is potentially subject to the tax, as is nonmaterial participation crop share or livestock share lease income. Simply running investment income through a pass-through entity that otherwise has trade or business income does not avoid the tax. Also, self-rental income is subject to the tax, as is royalty income," McEowen wrote in a January 4 newsletter.

The permanent estate tax exemption appears to be a great benefit. It also makes estate tax planning even more important.

That was the advice of Iowa State University Farm and Agribusiness Management specialist Melissa O'Rourke in a posting Monday on the Ag Decision Maker website.

"It is important that after the death of the first spouse that the unused exclusion amount is transferred to the surviving spouse as part of the estate proceedings – by timely and proper filing of a federal estate tax return, even if no tax is owed," she wrote. "The surviving spouse can use that unused exclusion amount plus their own exclusion to make lifetime gifts or pass assets through the estate of the second-to-die spouse. The surviving spouse should strongly consider filing the estate tax return even if the level of wealth does not appear to reach current exclusion levels since it is difficult to predict increases in estate values during the interim years. As always, families and individuals should seek advice from their personal tax and legal professionals."

O'Rourke points out that gifts made to your heirs before death will also count toward the $5 million exception, or unified credit. Yet, she added, "Remember, lifetime gifts within the annual exclusion amount ($14,000 in 2013) do not count against the lifetime basic exclusion (the $5 million inflation-adjusted amount). As an example, a couple can give unlimited $28,000 gifts in 2013 to as many different individuals as desired – and these gifts would not count against the lifetime exclusion."

All of these tax issues are compelling reasons for getting solid advice from tax professionals soon in 2013, for both short-term and long-term planning.

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