John Zoria, a third-generation grower who farms on the eastern edge of sprawling San Jose, has inherited a farmer's skepticism from his Italian-born father and grandfather. He showed his skepticism when asked about the Tax Reform Act of 1986.
"Well," he replied, "they sure didn't go through all this trouble to save us any money. I just assume I'm going to pay more."
Equally skeptical was the nationally circulated Farm Journal, which commented last month regarding the new depreciation rules: "The government figures that since crop prices are so low, you can spend your time keeping records rather than tilling the soil."
Family-owned Zoria Farms grows, dries and packs apricots and peaches. Zoria figures that new drying equipment and machinery bought last year will wind up costing about $17,000 more than anticipated because of Congress' elimination, later in the year, of the investment tax credit, which was made retroactive to Jan. 1, 1986.
"We didn't buy the equipment for the credits but because we needed it," he acknowledged. "But," he added, "we're going to have to be more on our toes now. I've had to rethink everything I've learned about taxes over the last 30 years."
Tax experts specializing in agriculture readily agreed with Zoria's last observation.
"Simplicity did not survive this bill," quipped Wayne Nichols, a farm expert in the Sacramento office of Arthur Andersen & Co. Moreover, in many areas, the Internal Revenue Service has yet to produce rules for carrying out the new law, observed Ron Herr, an economist with the American Farm Bureau Federation.
Herr, Nichols and tax analyst Jan Rosati at Touche Ross & Co. in Sacramento agreed also that tax reform's chief benefits for agriculture will only become apparent in the future through elimination of tax shelters for investors more interested in harvesting tax breaks than profitable crops.
"By flushing out the non-farmer from contributing to the oversupply situation--getting back to the business of farming--the law will strengthen the sector in the long run," Nichols predicted.
"We see that (effect) as positive in the long run," Herr said, "with the caveat that, in the short run, there's a tremendous amount of adjustment to be done, and it will take time to make those adjustments."
Among the major areas of "adjustment":
Elimination of the investment tax credit. Credits that were unused because of a lack of income to offset could be carried forward at 100% for 1986 taxes, but this will fall to 82.5% this year and to 65% after that. Half the value of unused credits can also be used to offset taxes paid in the last 15 years, through 1986, up to $750 a year. However, because farm earnings have been so depressed, some farmers may have difficulty finding any past income to offset, observed Hoy Carman, a professor of agricultural economics at UC Davis.
Loss of the capital gains exclusion. Certain commodities, such as timber and breeding livestock, have traditionally been sold to take advantage of the favorable tax treatment afforded capital gains. Farmers retiring or selling out have benefited from the exclusion as well, so for growers in that position the loss will be telling. (There is one exception to elimination of capital gains, however: Gains on dairy cattle sold before next Sept. 1 under the federal dairy-herd reduction program will still qualify for the 60% exclusion.)
Preproduction expenditures. Many farm assets, such as orchards, vineyards and cattle, take several years to become productive, but these preproduction costs could previously be deducted as they were made. The new law requires tracking of these costs, adding them to the purchase price of the asset--the "tax basis"--and then depreciating the higher-valued asset after it becomes productive. "That creates real bookkeeping problems for farmers," Herr said, "particularly for dairymen and cattlemen, and farmers don't know yet what kind of implementation rules the IRS is going to come up with."
Health benefits. The new law, in part thanks to farm-bloc lobbying, allows self-employed persons such as farmers to deduct 25% of what they paid for health insurance for themselves, their spouses and other dependents, when calculating adjusted gross income (though there are some limitations). Previously, these costs were not deductible as a business expense, only as an itemized medical deduction to the extent they exceeded 5% of adjusted gross income.
Depreciation. Depreciation rates, which were greatly shortened under the "accelerated cost recovery system," or ACRS, have been generally lengthened. The changes don't much affect such production equipment as tractors, but the depreciable life of a barn, which in 1986 was 19 years, now is 31 1/2 years, written off in equal annual increments. Such special-use buildings as hog pens, poultry houses and milking rooms, as well as most farm machinery, can be written off over seven years. Light trucks and autos are five-year property, as are beef cattle, but sows and horses have three-year tax lives.
"Expensing" property. The limit on how much depreciable property can be deducted as an expense has doubled to $10,000--so "expensing" rather than depreciating can help a farmer balance unexpected bulges in earnings. However, the amount deducted as expenses cannot exceed taxable income.
In addition to these points, loss of income-averaging will particularly affect orchardmen and vegetable farmers, said Herr, the farm bureau economist, since they traditionally expect no more than three good years out of five--a situation made to order for averaging a good year's income over two that were less profitable to reduce overall tax liability. "That's just the way their business is," he said, "and they need income-averaging."
Herr said inquiries from farm bureaus across the country indicate an emerging area of concern--the effect of federal tax reform on state revenues and, ultimately, on state taxes. For example, in Nebraska and three other states where the states' income taxes are calculated as percentages of a taxpayer's federal income tax liability, revenues are expected to decline.
In California, where the income tax system has generally paralleled the federal, the tax harvest is expected to increase under the new law, according to a study by the Washington-based Advisory Commission on Intergovernmental Relations, a congressionally created watchdog composed of federal, state, county and local officials. "The federal tax reform is forcing state governments to take a hard look at their tax systems," Herr said. And on the state and local levels, farmers, like other taxpayers, are affected not only by income taxes but property and sales taxes as well, and these could be changed by state and local governments responding to changes in the Internal Revenue Code.
"I look at it as kind of a new game generated by the federal tax reform," Herr said.