Tax Incentives Needed for Investors in Agriculture and Small Business

By:  Mark Cox, CPA - Wicks, Brown, Williams & Co.

We believe that agriculture and small business are the lifeblood of our economy and employment in the United States and that the US Congress should act immediately to provide an incentive for investors to again invest in agriculture and small business.

1986 Federal Tax Legislation began the limitation of deducting passive losses for investors of agriculture and small business. This legislation eliminated any incentive for investors to invest in agriculture and small business, and accordingly, has significantly reduced the investment of capital into these key businesses. Until these business sectors improve in financial performance, our economy will continue to struggle and unemployment will be high. It will be difficult for these businesses to strengthen without the capital investment.

Agriculture and small business are generally closely held entities that are not traded on the stock markets. Therefore, they are at a significant disadvantage to larger companies that are considered more liquid investments as they are traded on the stock markets. In addition, agriculture and small business carry additional investment risk due to their nature. Therefore, agriculture and small business need the tax incentive reinstated that will reward investors that invest in companies with less liquidity and additional risk.

Many of the agriculture and small businesses are organized as partnerships or S-Corporations for tax purposes while the majority of the large corporations listed on the stock exchanges are C-Corporations for tax purposes. Partnerships and S-Corporations do not pay taxes at the entity level (like C-Corps do), but instead, pass their profits and losses to their shareholders to report on the shareholder’s individual income tax return.
Since many start up agriculture and small businesses have losses in the early years, these losses would be passed out to the shareholders to deduct on their individual tax return up to the amount of their investment into the business. Until the 1986 US tax legislation, an investor of an agriculture or small business that was organized as a partnership or S-Corporation for tax purposes could begin to deduct these losses on their individual returns. The 1986 US tax legislation required passive investors, which are those that do not work in the day to day workings of a business, to suspend deducting these losses until they had profits passed to them from these investments or had profits from other passive investments. This legislation changed the tax treatment for an investor in agriculture and small business to be very similar to an investor in a large corporation, thereby, taking away the tax incentive to invest in these key economic businesses.

It should be noted that when the time comes to sell or liquidate the investment, that the investor would have a similar, total income tax effect over the life of the investment for either the large corporate investment or an investment in an agriculture or small business even if the 1986 US tax legislation was suspended. Therefore, at the end of the investment, the investor would pay similar income tax on any profits from the investment. The difference is that if the 1986 US tax legislation in regards to limiting passive losses were suspended, it would potentially allow passive investors to begin writing off there investment in the early years of the investment versus waiting to write off their investment until they sell or liquidate their investment.

This tax incentive proved to be effective in attracting the investment of capital into agriculture and small business prior to the 1986 US tax legislation. We urge the US Congress to suspend this litigation so that investors would again be encouraged to provide the necessary capital for agriculture and small business. This influx of capital would lead to the creation of new agricultural and small businesses and allow existing businesses to expand operations which would directly lead to new jobs and a drastically improved economy.