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Even before the election, Kansas Farm Bureau was urging members to ask Congress for a “virtual repeal” of the estate tax in the lame-duck session: an exemption of $5 million and a top rate of 35%. That falls between Mitt Romney's goal of repeal and Barack Obama's goal of keeping the 2009 exemption of $3.5 million and raising the rate to 45%. If current taxes expire this month, estate taxes revert to a $1 million exemption and 55% top rate.
Capital gains could rise, too, under a re-elected President Obama, prompting an online buzz over the wisdom of late-year capital asset sales.
Almost overlooked by the general public – but not farmers – is a new tax. On January 1, 2013, a 3.8% Medicare tax will apply for the first time to unearned or passive income from the sale of property or assets. It's intended to help pay for the 2010 health care law known as Obamacare.
High-income households (over $250,000 for couples filing jointly or $200,000 for individuals) also will pay 0.9% more on the existing Medicare tax on earned farming income, bumping the rate from 2.9% for self-employed farmers to 3.8%. The higher rate applies only to the income above the $250,000 or $200,000 threshold.
Marc Lovell, an attorney and tax specialist at the University of Illinois, has gotten calls from farmers who planned to sell land and who were worried that the new tax amounts to a sales tax on all of the proceeds.
It applies only to the gain, Lovell says. And many farmers wouldn't have to pay it. Only passive investors would.
“It's a little easier for the farmer to meet the material participation test than the normal taxpayer,” Lovell tells Successful Farming magazine.
As Lovell explains in an article published October 26 on the website farmdoc Daily, even farmers who don't perform physical labor on a farm can avoid the tax if they earn self-employment income for managing the farm, and regularly and continuously make independent decisions on things such as crop rotations or expenses for animal breeding, buying machinery, and directing a crop or herd manager.
A retired farmer isn't likely to be hit by the new tax, either. The retiree or surviving spouse is considered to be materially participating in the farm if he or she receives Social Security benefits and has participated in farming activity in at least five of the last eight years.
A bigger hit
Lovell thinks more farmers are likely to be affected by the 0.9% bump in earned income, especially if a spouse works off the farm.
“I think that's going to have wide applicability,” Lovell says. “It could be a pretty nasty surprise. There's no way for an employer to know what to withhold.”
The spouse's employer next year likely will withhold 1.45% of wage earnings (half of the ordinary 2.9% Medicare tax).
In his farmdoc Daily article, Lovell gives this example: A farmer, Don, has $160,000 in Schedule F earnings. His wife, Linda, has wages of $180,000 off the farm. They'll pay the regular 2.9% of Don's earnings, or $4,640 in Medicare taxes. And they'll pay $1.45% of Linda's $180,000, or $2,610. Their combined total of $7,250 would apply to all taxpayers.
But because their joint income is $340,000, or $90,000 above the $250,000 threshold, they'll also owe another 0.9% on that $90,000, or an additional $810. That off-farm example is higher than normal, but on-farm income could just as easily push a couple above the threshold. “Nobody would know until the return is done,” Lovell says.
A lawsuit is still pending that challenges the constitutionality of Obamacare due to the law's origination in the Senate, instead of the House, where tax laws should originate. That could still make the health care act moot. If not, Lovell says subchapter S corporations may be used to avoid some of the tax.