Your REAP Questions Answered
We recently interviewed Joel Semke, REAP coordinator for the Pennsylvania Department of Agriculture and State Conservation Commission.
The Resource Enhancement and Protection program (REAP) allows farmers, landowners and businesses to earn tax credits for implementing Best Management Practices to enhance farm production and protect natural resources. The program has been in place since 2007 and has been an excellent resource for the agriculture community while protecting our air, land and water. Joel discussed REAP and common questions about the program.
Could you give a quick, high-level overview about REAP and how farmers utilize the REAP program?
REAP started in 2007 with a partnership between Chesapeake Bay Foundation and some other state agencies to help farmers fund water quality projects with the goal of reducing nitrogen, phosphorous and sediment runoff to local streams, and ultimately the Chesapeake Bay.
REAP is a statewide program. Every year our funding covers about 350 applicants, so we have many people across the state applying and getting approved for REAP credits.
Each year there is a $13 million annual allocation of income tax credits. The program reimburses farmers in PA state income tax credits, which they can use dollar-for-dollar to pay that PA income tax bill over the course of 15 years. The program has another option where farmers can sell them or transfer them to other members of the business, family members or other individuals.
The program has been very sustainable. We use up all of our allocation each year, and it's proved very popular farmers, the PA legislature and others.
Moving forward, we hope to continue to reach out and get new farmers into the program, especially with certain communities that don't use traditional funding programs.
When working with our Horizon customers, we often get questions related to the tax treatment of the REAP tax credits. Specifically, what happens when let’s say an LLC (which is treated tax-wise as a partnership), is awarded the credits?
REAP tax credits are awarded to either an individual social security number or an EIN for the business, which could be an LLC, a partnership, an S-corp, etc. Many of family farms are set up as a business such as an LLC, and we get lots of REAP applications in the form of an EIN. The tax credits are awarded to that EIN and then come tax time, they're passed through to the individual members of that entity, just like the income is.
Farmers can use credits over the course of 15 years, so the 15-year carry over stays at the LLC level in this example. The credits stay sort of parked, so to speak, in that EIN account. Every year the business entity has to dictate to the Department of Revenue, how they're going to be passed through to the individual members and that happens on the PA REAP claim form. The first step is to figure out what the tax bills are going to be for the individual members, and then pass through that amount. The individual members can pay 100% of their PA income tax bill with the credit.
I’m not an accountant, but I’m trying to provide a broad overview on some general concepts here. Farmers should always reach out to their accountant or financial advisors when discussing tax credits.
As I was saying, the credits get passed down just like income. What happens if the individual members of that business entity have dramatically different tax bills? Let's say one member has their PA income tax ending up being zero. That could potentially impact how the other members can use the tax credits, because they're passed down according to membership stake. If somebody owes zero to the state, they can't have credits passed to them, and so then the other members will be impacted by that.
In transferring or passing through any credits like this, those credits can't be rolled over. You can only pass down what a person can use for that tax year. That's very important to remember when you're talking to your accountants.
Come April or March, I'm very glad that I'm not an accountant trying to deal with all those calculations. It is a factor that folks in LLCs, partnerships and S Corps need to remember when they're figuring out how much to pass through to individual members.
A key part of the program is that REAP tax credits may be sold to individuals or corporations wishing to reduce their tax liability by purchasing the tax credits. First, if a farmer is interested in transferring credits to other friends or family members, how does that work and are there any considerations to keep in mind?
Credits can be transferred down to other family members or friends, or whoever really. Or they can be sold.
Two things have to happen first before a farmer can transfer or sell credits. First, the farmer or the primary recipient of this credit, needs to use that credit in the year that it's issued first. Even if you only owe $10, you need to use that credit to pay that $10. Then that frees you up for the second part where you need to wait one calendar year.
For example, if a farmer in 2020 had a credit awarded sometime during the year in 2020, the 2020 tax year is the first time that they can use that. Right now they want to claim this credit to pay that 2020 bill, if they owe anything. If they don't owe anything, that requirement is waived, and you move on to the second requirement, which is to wait one calendar year.
Whether you're transferring it or selling it, you have to wait until the date of issue is on their credit plus one year, and then you can submit an application to sell it or transfer it. That application to sell it or transfer it is the same. When you're transferring it to a family member, you're just selling it to them for $0.
It’s important for farmers to remember that the sale or transfer has to happen before December 31 of whatever tax year we're talking about. Therefore, farmers and family members need to do tax planning the year before. They’ll need to think ahead and figure out how much they're going to owe (or what they think they're going to owe). Then, they need to get that application to me prior to December 31.
For the recipient of the transfer, they can only pay 75% of their PA tax bill with the credit so that's one further calculation that you need to do before you submit that application with the amount. Because again, if you transfer more than the person can use in any given year, that unfortunately is lost. There's no ability to roll that over for next year or put it back into the account of the primary recipient. The big thing is to plan ahead.
I recommend that farmers get me those applications to me by December 1, because really that gives them a chance, if something goes wrong at Department of Revenue, they have a chance then to correct that issue and get it done prior to December 31.
Next, tell us more about the “sponsorship” option for tax credits. How does that process work, and are there any tips you have for farmers who may take this approach?
Sponsorship was included in 2007 with the original REAP law. It was envisioned as a way for businesses or other individuals to get involved with their local ag community to help farmers implement water quality conservation practices on their farms.
The way it works is the sponsor is the applicant to REAP. The credits go to that sponsor for their input, and their funding that goes to the farmer. For the farmer, they submit the application based on their eligibility. The eligibility for REAP is based on the farmers' compliance with the law, but the sponsor is the applicant and the credits go right to that applicant.
In the last two years we’ve had about 50 sponsors of REAP. There's really very little restriction on who can be a sponsor, and this could be an opportunity area for the future.
The only restriction is that that sponsor has to be liable to pay some sort of PA income tax. So any business, individual, trust or bank can act as a sponsor. The rules written right into law back in 2007 are intentionally vague about sponsors. A sponsor helps fund the project. There has to be a written financial agreement between the sponsor and the farmer. However, the state, myself and the State Conservation Commission, don't ever see that agreement.
It’s wide open what the farmer and sponsor agreed to in terms of details. It’s up to the farmer and the sponsor to determine how everything will work. A question might be if a sponsor going to fund things upfront and then receive the credits after the project is done? Or is the farmer going to take care of all the business, pay all the bills, and then the sponsor's going to reimburse them and get credits at that point? Again, it’s up to the agreement between the farmer and the sponsor.
The things that I need to see on a sponsorship application is just the check box that there is a financial agreement and then also addendum agreements to make sure that everybody understands who's responsible for maintaining that project. The farmer is the one that has to maintain it, even though they didn't get tax credits for it. Instead, they got cash.
Let me clarify, the sponsor gets the tax credits. The tax credits can use them for up to 15 years, and they can carry them over year-to-year.
For the farmer, they just see cash because of the involvement of the sponsor, which might be better for their current operation. It gives them a bit more flexibility in dealing with cash rather than PA REAP income tax credits.
Another aspect of sponsorship that's beneficial to farmers is that there's no cap. When farmers apply on their own, there is a limit - a $250,000 credit limit that they can receive in any seven-year period. With sponsorship there is no cap.
When farmers are working on really big projects, such as a project that is $500,000 or more, sponsorship can be a great option because the sponsor can receive that entire amount as tax credits whereas if the farmer had applied on their own, it would be capped out at $250,000.
Other key benefits are all the rights and privileges of getting that credit. The sponsor gets the 15-year carryover of that credit to use it. There's no cap. They can pay 100% of their tax bill with that credit, rather than in contrast to what I said about selling and transferring instead of that 75% rate that they could have if they bought the credits.
We've been working hard the last two years to try to ramp up the use of sponsorships, to make sure farmers are aware of it and understand it. It can help with the immediate cash flow of a farm's operation. The downside is the farmer gets cash from the sponsor, which is reportable income rather than a tax credit, which is not reportable income. Additionally, they don't have that flexibility of a tax credit over the course of 15 years. When a farmer receives cash, that's all in one year, and one time to deal with all the bills and whatnot. Whereas with a tax credit over the course of 15 years, a farmer could use that for unforeseen circumstances. In certain years where you sell a lot or the economy is great, the tax credit can be very useful in those years.
Another concern to consider is that farmers are not always fully in control of the timing because the credit is issued after Department of Revenue does a compliance check on that sponsor, which you, as a farmer, you can't control the tax compliance status of the business down the street.
However, in general, the 50+ farmers that have used this process over the last few years have generally been pleased with it and feel that more farmers across the state could take more advantage of.
If you have questions or concerns, or want additional details, please reach out to me. I can help answer questions as best I can.
What other common questions do you get from farmers about REAP?
We’re in the midst of tax season, so one common question I get is about claiming credits.
We have about 300 to 350 farmers that use the program every year, so while it can seem daunting at first, many farmers are getting good at using tax credits. At this point, the state has awarded almost $105 million worth of tax credits to farmers all across the state. About 60% of those credits are being used year-to-year on PA income tax returns. I say that to encourage farmers. It might seem like a daunting process at first, but plenty of people are doing it. Also, man accountants around the state are getting used to the system, so it can be done.
This time of year, claiming this credit is really a two-part process for the paperwork. The first step is figure out how much you owe on your PA income tax. The second part is to fill out the REAP claim form with that amount. You figure out how much you owe and then you claim it on the REAP claim form, which gets faxed to the number at the bottom of that form.
This is a key misstep. The claim form has to be submitted to a separate address. If you don't do both parts of this process, that can hinder the use of these credits.
To wrap it up, know that there are many farmers who are taking advantage of this program. Accountants are certainly getting more familiar with REAP, and I’m here to help too.
We will accept fiscal year 2020 applications until March 1. Our funding for this fiscal year is almost gone, but there is no harm in submitting an application. If you're hearing this and you have a project in mind, please submit an application. If we don't have funds for you, you just get rolled over to next summer, 2021 summer, for our next pot of funding. You don't have to resubmit new paperwork or anything like that. If you have something in mind, please apply.
Are there any thoughts you would like to share with our listeners today?
I'm always happy to hear from farmers and help them learn more about REAP. Feel free to call me at 717-705-4032 or email email@example.com.