By Sarah Gonzalez, Director of Communications and Digital Media
Lawmakers are promising to overhaul the tax code for the first time in 30 years. While initial proposals dramatically reduce tax rates, businesses are seeing a map of changes that could lead to even more complexity.
One of the most important tax provisions for businesses in the grain, feed, processing and export industry is the ability to deduct interest. Interest deductibility refers to the ability of businesses to deduct the interest paid on debt from their taxable income. The NGFA and several other national agribusiness groups are communicating with House and Senate members to advocate for beneficial tax reform, including maintaining interest deductibility, as the interest paid on business loans has been 100 percent tax deductible for the past century.
“[Interest deductibility] is a necessary business expense…because of the cyclical nature and the seasonality of our business. And we have low margins on top of that,” explained Larry Callahan, chief financial officer at Demeter LP, and chairman of the NGFA’s Finance and Administration Committee, in a conversation with the author. “We need that capital and it’s hard to tell when we’re going to need it. To keep our cost low – and actually get a return – we need that deductibility.”
The BUILD Coalition, an organization representing a variety of business sectors, says interest deductibility is a core component of the tax code going back 100 years.
“Debt and equity are not interchangeable financing options,” the Coalition explains in its lobbying material. “Many businesses lack access to equity capital markets. Even when equity financing is available, it is typically more expensive than borrowing and often involves relinquishing some level of ownership. Borrowing is therefore often the best way for businesses to fund their operations, create jobs, and grow.”
BUILD Coalition spokesman Mac O’Brien said placing a limitation on the deduction of interest expense “amounts to a new tax on American job creators who borrow to invest and grow.”
The House Ways and Means Committee on Nov. 2 released its legislative proposal on tax reform, and the committee mark-up still is underway. The proposed plan reduces the corporate tax rate from 35 percent to 20 percent and eliminates the often-cited estate, or “death,” tax within six years. However, changes to interest deductibility are more likely to have a greater impact on a greater number of agricultural entities than the estate tax. Under the House’s initial proposal, small businesses with average gross receipts of less than $25 million would be exempt from any reduction in interest deductibility. However, above that level, interest deductibility would be limited to 30 percent of adjusted taxable income.
“We believe it’s a significant change that’s going to increase taxes on customers of CoBank and the Farm Credit System,” said Brian Cavey, senior vice president of government affairs at CoBank, in a conversation with the NGFA. Cavey said changing the rules of interest deductibility will have some impact on every entity – large and small – to which CoBank lends.
Callahan made similar comments, adding that exempting businesses based on gross receipts doesn’t make much sense. “Trying to define a small business is impossible. Gross receipts have nothing to do with size; it ignores business realities,” he said, noting that within the NGFA’s membership, most companies far exceed the $25 million exemption. Further, Callahan said limitations on interest deductibility may promote further consolidations within the industry.
While exact predictions are difficult to make as the proposal can change at any time, CoBank’s Cavey noted that, at the very least, “Putting a cap out there is going to drive business decisions to meet new tax rules. That’s contrary to what’s being used as the justification for doing tax reform.”
The House proposal also includes a special 25 percent tax rate on pass-through businesses, such as partnerships and S corporations, which pay business taxes through the individual tax system. (For C-corporations, income is taxed at both the corporate level and as that income is paid out, but income from pass-through entities is taxed once.)
The House’s proposed rule for pass-throughs would allow just 30 percent of the business income to be taxed at 25 percent. The remaining income would be taxed at the business owner’s individual tax rate.
If the new rule becomes law, Callahan said some pass-through businesses, such as Demeter LP, may consider whether it makes more sense to convert to a traditional C-corporation, for which the proposal would cut the tax rate to 20 percent, while earnings still are taxed a second time.
While the House Ways and Means Committee wrangles over tax reform, the Senate Finance Committee is expected later this week to unveil its tax overhaul proposal, which is constrained by budget rules barring Senate Republicans from adding to the federal debt after 10 years. Meanwhile, significant changes are likely to be adopted in the House proposal before it makes its way out of committee, and it’s still unclear how the Senate’s bill will differ from the House version.
“It’s going to be a tough row to hoe…there’s not a lot of time to build a consensus,” said Callahan, referring to Congress’s ability to pass tax reform this year.
In the meantime, Republicans in both chambers have said they want to simplify and lower taxes. Unfortunately, “it looks like they’ve added complexity for business,” Callahan noted.