The sacred cow of cash accounting targeted

Feb 21, 2014
by DTN

—Tax reform “simplifications” sends ag shivers

Some of agriculture’s most valued sacred cows could fall victim to tax reform legislation about to be debated in Congress.

Cash accounting—a time-honored method small businesses use to ease their taxes on income they have yet to receive— could be severely restricted, along with depreciation schedules on farm equipment and buildings and the use of 1031 tax-deferred exchanges on real estate.

While the objective of such legislation is to simplify the U.S. tax code for the first time since the 1980s, small business owners worry that they may end up footing the bill for breaks to big business. Last month, more than three dozen agricultural organizations including the American Farm Bureau, the National Cattlemen’s Beef Association, National Corn Growers Association, National Pork Producers Council and the American Institute of CPAs sent letters to the Senate Finance Committee opposing changes to cash accounting rules.

Neil Harl, an agricultural tax expert and Emeritus Professor at Iowa State University, sat on a federal tax panel that had cash accounting in its sights in 1967. The topic was so explosive that IRS shelved the idea and no one seriously raised the issue until about 18 months ago, Harl said. Even now, he doubts reformers could pass such a revolutionary change in tax policy.

“There is simply too much opposition for it to go anywhere in my view,” Harl said. “More than 90 percent of farm taxpayers are on cash accounting and would almost across the board be opposed.”

Logjam to end

Despite objections, controversial draft proposals issued by the House Ways and Means and Senate Finance Committee late last year appear to be making headway. Last Wednesday, House Ways and Means Committee Chairman Dave Camp informed Republican members of his panel that he would release a comprehensive discussion draft to overhaul the tax code this week.

Brian Kuehl, Director of Federal Affairs for Kennedy and Coe LLC, a Kansasbased accounting firm, worries as much as 73 percent of the U.S. beef production and 30 percent of the U.S. milk supply could fall under much tighter accrual accounting rules when they are unveiled. Legislative proposals, in their current form, would require firms with gross sales above $10 million to use accrual accounting for tax purposes. “We really don’t want this thing to get legs,” Kuehl told DTN.

A recent Kennedy and Coe and Farmers for Tax Fairness study, prepared by Informa Economics, estimated that if cash accounting changes were enacted, agriculture would be forced to pay $4.84 billion in accrued tax liabilities but have only $1.4 billion in current cash on hand to pay the additional tax burden. Typically, farm and ranch owners would owe taxes at retirement or when their businesses are sold, but they would have to owe deferred taxes immediately and be able to pay during a one-time, four-year transition period.

The problem is that “many farmers will not have adequate cash on hand to cover the tax bill and continue farming without increasing their borrowing,” Kennedy and Coe’s study concluded.

To show the benefit of cash accounting, the study used a 5,000-acre corn grower who earned between $3 million and $4.6 million annually between 2010-2013. He’d normally fall inside the $10 million gross sales limit, but perhaps not if other businesses were aggregated.

Using cash accounting to spread out his tax bill, the grower would have paid $265,572 in federal taxes each year. Using accrual records, his tax bill would have swung from a high of $523,997 in 2011 to $193,396 in 2013. Because the grower would be thrust into higher tax brackets, he’d pay $485,000 more in taxes over that four-year period compared to a cashbasis taxpayer, Informa calculated. The cash-basis operator would pay the difference when he quit farming, so obligations would reconcile eventually.

Exemptions for agriculture on the accrual accounting rules make sense, Kuehl added. “Unlike other industries, agriculture operates on tighter margins, higher capital needs and higher risk,” he said. What’s more, animal agriculture’s revenues are tied up in the biological cycle, so revenue may not materialize for several years as bred animals give birth and the next generation is fed to maturity.

While $10 million in gross sales sounds like big business, the rules could actually affect many smaller operations, Kuehl also noted. So-called “aggregation” rules would lump gross sales of related businesses together. For example, many operators may own partial shares or majority shares in grain elevators, trucking businesses, excavating businesses, shares in a sow co-op or even a cotton gin. The same aggregation rules now apply when determining if employers reach the 50-employee threshold under the Affordable Care Act and are some of the most complex of the tax code.

Major rule changes on accrual accounting and depreciation could be particularly “nasty” for largerscale livestock operations, say other CPA firms that specialize in agriculture. “Hardly any farm asset would be better off under these proposals, but for livestock guys it’s horrible,” Paul Neiffer, a Yakama, WA, CPA with Clifton- LarsonAllen.

For example, specialty livestock buildings like dairy parlors or confinement hog and poultry operations would be depreciated over 43 years in the Senate plan, versus 10 years under current law. What’s more, any property put in service prior to enactment would be subject to the slower depreciation schedules, so some features threaten to be retroactive.

“Farmers who bought $1 million worth of combines can fully depreciate them over eight years now, but it would take 35 years to fully depreciate them under this proposal,” Neiffer said.

Neiffer admitted there were some positives in the Senate proposal. For example, Sec. 179 depreciation would be set at $1 million and phase out beginning at $2 million. Currently, businesses can write off $500,000 of Sec. 179 property in 2013, but the limit reverted to $25,000 in 2014 unless Congress enacts a change.

Farm realtor and broker Ray Brownfield of Oswego, IL, is particularly upset about Senate staff proposals that would end the use of 1031 tax-deferred exchanges. Those tax deferrals have been commonly used by farmland owners around metropolitan areas whose land has been gobbled up by development. In those cases, owners can exchange existing real estate for similar property elsewhere without an immediate tax liability, so it keeps existing farmers operating but in different locations, Brownfield said.

If families can’t get along as joint owners after an inheritance, some owners split their inherited property and use 1031s to buy land elsewhere, he added.

“This mitigates terrible taxes and perpetuates land ownership,” he said. It really wouldn’t happen if someone had to pay immediate capital gains taxes because that could reduce funds for their second investment by half, he added.

“Obviously, Congress seems to want the money now, not three or four generations from now,” Brownfield said. — Marcia Zarley Taylor, DTN