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July 2011 Archive for The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

The Pacific NW Wheat Harvest is Late!

Jul 30, 2011

My wife and I rode our motorcycle from Yakima to Lewiston on Thursday with a stop in Walla Walla.  Normally this time of year, wheat harvest would be in full throttle, however, I noticed very little harvesting going on that day.

I visited with my Uncle and Aunt at their house on Thursday and spoke with my cousin.  Usually wheat harvest would start around the 15th of July (some years around the 4th even) but this year, they will be starting their first field for harvest sometime next week.  This is by far that latest harvest that I can remember for this area.

The good news is that the average yield should be on the high end, but a lot of wheat is down on the ground and it will be harder to harvest.  One of my least favorite things growing up on the farm was harvesting downed wheat.  Usually this wheat would have high yields unless it went down too soon, then it would not finish filling out.

I will be driving combine around the 10th of August and will let you know how the fields look.

My wife and I spent the night in Lewiston and then headed down to Enterprise and Joseph, Oregon which has some of the prettiest scenery in America.  This area is called the Alps of America and if you ever get out this way, you need to check it out.  I noticed several combines harvesting grass seed over in the LaGrande area and based upon the straw I saw, the yields look good there, but you never know for sure with straw.

Then as we got closer to home along the Columbia River, the onion harvest was in full swing and when you are on a motorcycle, you can really smell that harvest.

Fresh Garbanzo Beans to Hit the Market This Year

Jul 27, 2011

I grew up in the Walla Walla area and several farmers are now producing Garbanzo Beans on about a 1,000 acres for the fresh frozen market.  Normally, garbanzo beans are held to maturity and harvested dry and then shipped around the world.  The Middle East is a large consumer of these beans and in the US they are primarily used in soups and salads.

Work started in 2000 to come up with the method to freeze the beans for the fresh market.  They have just now perfected the process and you will be able to buy fresh garbanzo beans in a market near you.

The beans are harvested using the normal green pea combine (which cost over $500,000 new) and then chilled to about 36% near the Walla Walla airport.  After chilling, the beans are then transported to Ellensburg, Washington about 150 miles away to be frozen and then shipped to customers.  I am impressed that they can get these things harvested with a green pea combine since the plants are only about a foot tall, but the picture in the article indicates they can get most of the plant into the combine.

On a personal note, the farmer Ron Filan quoted in the story is my cousin.  Here is the article.

IRS Extends Time for Innocent Spouse Relief

Jul 27, 2011

The IRS in Notice 2011-70 has extended the time that an innocent spouse can request equitable relief from the current two year limitation to the amount time remaining under the statute of limitations for collection procedures.  This is a very nice change from the IRS since they had recently won a couple of court cases mandating that the two year period was valid.

I believe that the IRS realized that there were many cases where a spouse had been wronged in the filing of income taxes and extending the time period was not just warranted, but good policy.  The innocent spouse provisions allow a spouse whose husband or wife has filed a joint tax return with major errors or other issues to get equitable relief.  With out the innocent spouse provisions, by signing a joint return, the innocent spouse would be subject to paying taxes, interest and penalties that were really the other spouse's responsibility.

These provisions allow the innocent spouse to request relief from these taxes, interest and penalties.  This is a good change.

John Deere to Fight For GPS

Jul 25, 2011

USA Today just ran an article on how John Deere is leading the fight against Lightsquared plans to put up more than 40,000 new cell towers in rural America.  John Deere is worried that the spectrum that Lightsquared want to use will bump the GPS spectrum and lead to farmers having issues running their GPS on tractors and combines.

Since this is most likely a political fight, it may make sense for farmers to let their representatives know how important precision farming is.

Another nugget from the article is how flush farmers appear to be with cash right now.  The John Deere Finance arm is having a hard time drumming up business since more farmers than in the past can pay cash for their equipment.

Batman Was a Farmer!

Jul 21, 2011

I grew up on a wheat farm near Walla Walla, Washington and one of my next door neighbors was Batman, Adam West that is.  As a young child, one of my favorite shows growing up was Batman (however, as I got older, the show got a little cheesier).  Adam West, who was Batman, grew up on a wheat farm not too far from where I lived.

Here is an article describing his career and note the reference to his farm background.

A Switch in Farm Loan Levels

Jul 21, 2011

The Federal Reserve Bank of Kansas City just published their National Trends in Farm Lending for the second quarter of this year.

Due to the increase in input costs, operating loan levels have increased dramatically from the second quarter of 2010, up nearly 36%.  The number of livestock loans dropped slightly from the year before, however, the average loan amount almost doubled, pushing the volume of livestock loans more than 25% higher.

Capital spending on the farm for machinery and equipment seems to have cooled during this quarter.  Loan volumes for farm machinery and equipment plunged from a first quarter spike and were 36% below the year-ago levels.  I have a feeling that the 50%/100% bonus depreciation enacted late last year has soaked up a lot of the demand for new equipment and these types of sales may remain low until year-end.

The average borrowing rate on operating loans fell from 5.3% to 4.7%, however, the rate for equipment loans did incur a slight uptick to almost 5.4%.

How Does Section 1231 Work?

Jul 20, 2011

We had a reader ask the following question:

"I'm thinking about selling a tract of timber on land that was gifted to me 7 years ago. What can I expect the tax consequences to be? I'm a self-employed farmer."

We have done a couple of posts lately on capital gains treatment of the sale of equipment and other farm business property.

We thought it would be good to review the rules of Section 1231 since they apply to most of these sales.  Section 1231 governs how the sale of business assets is reported and taxed.  It is actually a fairly nice feature in that any Section 1231 gains are usually treated as capital gains and any losses are treated as ordinary and immediately deductible losses.

For example, lets assume a farmer sells a tractor for $25,000.  They paid $20,000 for it ten years ago and have fully depreciated it.  The first $20,000 of cost basis is considered Section 1245 recapture and is always treated as ordinary income.  The excess $5,000 gain is considered Section 1231 and will enjoy capital gains treatment.

Now lets assume the farmer sold the tractor for $15,000 and they had just purchased it for $20,000 and had not taken any depreciation.  In this case, the $5,000 loss is considered a Section 1231 loss and will be ordinary and immediately deductible.  The reason for it being ordinary is that the law assumes the taxpayer had not yet been able to take the full depreciation allowed to get it down to its actual value at the time of sale.

There is one negative to Section 1231 gains and that is the five year look-back recapture.  If, during the last five years, the farmer had net Section 1231 losses reported on their return and they have a Section 1231 gain this year, part or all of this gain would be ordinary. 

For example, assume a farmer had reported a Section 1231 loss in 2008 of $5,000 and had a Section 1231 gain this year of $10,000, then $5,000 would be ordinary and $5,000 would be capital gains.

For our reader, since it appears this tract of timber was gifted as an investment, the gain on the sale should be treated as a capital gain and subject to a maximum federal tax of 15%.

What Is The Tax Rate On Gifted Equipment?

Jul 18, 2011

We had a reader ask the following question(s):

"Paul, in regard to the capital gain question-we are in the process of purchasing a new corn planter. If we sell the old one for cash, how much will the capital gains tax be on it?  15% or normal income tax rate?  It was gifted to us many years ago from my father. So the basis would be zero dollars. The new purchase would be section 179."

 

When a farmer acquires a piece of equipment in the form of a gift, the basis to the farmer is the lower of fair market value or the basis in the hands of the person making the gift.  In most cases, the equipment has been fully depreciated before gifting it away, therefore, the basis is zero.  However, the person receiving the equipment must determine what the original cost of the equipment and accumulated depreciation since the equipment is still considered to be Section 1245 property (even if the person receiving the equipment is not farming).

This means that when the farmer sells this gifted property, the sales proceeds up to the original cost is ordinary income and any proceeds over original cost would be capital gains (subject to certain look backs for Section 1231 losses taken in the last five years).

So, the bottom line answer for our reader is that the sale of the equipment will be ordinary income up to the original purchase price and capital gains on any excess.  If the farmer is self-employed, the sale of the equipment will not be subject to self-employment taxes and the Section 179 on the new piece of equipment will reduce self-employment taxes.

IRS Gives Automatic Three Month Extension to File Form 2290

Jul 18, 2011

We wrote a post a couple of weeks ago about the possible late filing of form 2290 to report the excise tax owed on semi-trucks owned by farmers for the period ended June 30, 2011. 

The IRS has just issued release 2011-77 indicating there is an automatic three month extension until November 30, 2011 to file the return.  The IRS is also indicating that no payments should be remitted until after November 1, 2011.

The release also indicates that the states are required to accept the schedule 1 that was stamped by the IRS for the previous year's return.  This will allow farmers to register their trucks with the state or local authority.

The Three Levels of Farm Accounting

Jul 14, 2011

I am going to hazard a guess that at least 90% of our farmers are in what I call the first level of farm accounting. This is the old tried and true favorite - Cash basis of accounting. Most farmers report farm net income on their tax return using this method of accounting. Income is recorded as cash is received and expenses are recorded as they are paid. Most of these farmers use this method for their management of the farm business which does not accurately reflect the net income of the business.

The second level of farm accounting builds on cash accounting by at least recording the fair market value of crop inventory (crop harvested, but not yet sold) and possibly the value of the cost of growing crop. This amount is usually booked at year-end and is used for the financial statements presented to the bank. If the farmer is not doing these statements, we know that the banker is for sure is doing it and you should get a copy from them. This method of accounting gives a better picture of your overall farm profitability, but only when you book the fair market value adjustments (which is usually at year-end).

The third and highest level of farm accounting is using accrual accounting on a real-time basis. This means that as you purchase input costs for the farm, they are booked to a cost of growing crop inventory account and once the harvest is completed, these accumulated costs are then transferred over to a harvested crop inventory account and deducted as the crop is sold. This gives you the truest picture of what your actual profit is at any point in time.

The most successful farmers are at least in level two and most are making the changeover to level three.

What level are you at and what steps are you doing to get to the third level.

 

Wheat Market Update with a Northwest Bent

Jul 14, 2011

The Northwest Farm Credit Services has just posted a nice four page summary of winter and spring wheat conditions in the Pacific Northwest.  This growing region includes Washington, Oregon, Idaho and Montana.

The region has been especially cool and wet this spring with most typical harvest delays of at least two weeks.  Stripe rust appears to be a large problem this year due to the weather and many growers have had to apply fungicide at least three or more times to combat it.

However, even with the weather  issues, most every grower in the region will have an above average crop.  For example, growers in Montana that might enjoy 50 to 80 bushel yields are expecting 80 to 100 bushels this year.

I am personally going to help my cousins in the Walla Walla area harvest for a few days next month and I would expect to be harvesting wheat that may approach 140 bushels or more (remember driving a combine is my idea of a vacation).

Calculate Your Monthly Social Security Benefit

Jul 13, 2011

The Social Security Administration has a nice retirement calculator on their website that will project what your monthly social security benefit will be if you retire at:

  • Normal retirement age (for most of us this will be somewhere between age 66 and 67),
  • Age 70, and
  • Age 62

 

The calculator takes into account your current age, last year's income.  You can also tell it how much you think you will earn each year until retirement and what age you are planning on retiring at and it will calculate the monthly benefit.

This is a nice feature to have and now you do not have to wait for the annual letter to show up from Social Security letting you know what your benefits might be.  However, you should review that letter each year to verify that Social Security has the right amount of earnings listed.  I have seen several mistakes on these letters.

Think Savings Account for Partner's Capital Account

Jul 11, 2011

In almost 30 years of being a CPA, I have found partnership taxation to be one of the most complicated areas of taxation, both for other CPA's and for clients.  Partnerships involve both inside and outside basis, step-up or down in cost basis for certain transactions and many other compilations that are not there with corporate or individual taxes.

One area that is especially vexing for clients is to understand how their capital accounts.  I have found it easier for my clients to view their capital account like a savings account.

When you put money into a savings account, the first initial contribution becomes your balance.  The same is true with a capital account.  When you first invest in a partnership, the amount of cash (or property) that you put into the partnership becomes your balance.

A savings account with earn interest during the year.  A partnership will also have earnings during the year and your share will be allocated your capital account.  The beginning amount you put in plus your earnings becomes your new balance.

If you withdraw cash from your savings account, your balance will go down.  The same is true with a capital account.  If you take cash out of the partnership, your balance will go down.

On some savings plans (such as CD's), if you take your money out early, you will pay a penalty and your account will go down in value.  If the partnership losses money, your account will go down by your share of the loss.

Remember, a partnership capital account can go up in two ways:

  1. You put money or property into the account, or
  2. You have earnings allocated to you.

 

Conversely, a partnership capital account can go down in two ways:

  1. You take money or property out of the account, or
  2. You have a loss allocated to you.

 

This is the very simple way of looking at partnership capital accounts, but I think it will allow you to understand how they work.

Expect Filing Delays of Form 2290 for Many Farmers

Jul 08, 2011

The IRS has indicated in a couple of announcements (most recent one here) that the form 2290 excise tax return for the year beginning July 1, 2011 and ending June 30, 2012 and for the quarter beginning the same date will be delayed for some unknown time.  As was with the new tax laws passed in December of 2010, this delay is beyond the control of the IRS since they are waiting on Congress to make a decision.

Farmers are usually required to have a copy of form 2290 to present to their local state licensing office when renewing the tabs on their larger trucks.  The IRS indicates that the local licensing office should accept the July 1, 2010 to June 30, 2011 filing instead and if not, they can call an IRS representative (if they feel like waiting on hold for up to an hour which is my normal experience lately).

As Congress and the President continue to dither on the debt ceiling bill and other related matters, we may see more delays in forms just like this one.

Dying Days of Ethanol Subsidies?

Jul 08, 2011

The Wall Street Journal in today's paper had a good article on how ethanol subsidies are even closer to being eliminated.  Under the proposed deficit-reduction plan proposed on Thursday, the 45 cents a gallon blenders credit would be eliminated, however, more than $600 million of aid would be given to service stations to help promote the sale of ethanol.

As long as the mandate remains in place to produce a certain number of gallons of ethanol each year, the eliminate of the blenders credit will most likely have little or no effect on the price of corn.  The credit is simply an additional way of transferring additional revenue to the refineries and does not go directly to any corn grower.  It may affect the price the refinery is willing to pay a little bit, but with the mandate in place, they still have to purchase the ethanol.

It will be interesting to see how this finally turns out.

Mexico to End Tariffs on Fruit & Other Ag Products

Jul 08, 2011

There is an old saying that when politics gets involved, farming can suffer.  One of the prime examples of this was issue of allowing Mexican truckers to bring products into the US by truck which was allowed for several years.  However, politics got involved a few years ago and the US stopped this and Mexico retaliated by imposing tariffs of up to 45% on certain Ag products exported by US farmers. 

These tariffs taxed about $2.4 billion of products and were especially burdensome to the fruit growers in the US.

Now the good news.  As of Wednesday, July 6, 2011, both the US and Mexico have agreed to allow the truckers back into the US.  As a result of this signing, Mexico will cut in half their tariffs within 10 days and eliminate the remainder once full cross-border traffic begins.

This is good news for our farmers.

Watch For The State Tax Grab!

Jul 07, 2011

Most farmers enjoy certain state tax exemptions that are not always available to other businesses in that state.  For example, in my state of Washington, almost all businesses pay a state Business and Occupation (B&O) tax based upon gross sales.  As a CPA, our firm pays a 1.8% tax on all of our services performed in the state and there are very little deductions available to offset against this calculation.  Most retail and wholesale businesses pay about .5% on their gross sales under this tax.  However, this tax does not apply to farmers in our state.

If this tax applied to a farm operation with about 1,500 acres of good wheat land at 100 bushels per acre and $7 wheat, the total B & O tax owed would be about $5,000 that is not owed now.

During our last legislative session, many groups wanted to get this exemption eliminated, however, farmers were able to get their voice heard and keep the exemption.  But with states seeming to need more and more money, it is probably just a matter of time before this exemption is gone.

Another area of attack is eliminating the exemption on sales of the purchase of chemicals, fertilizers and repair parts. 

Every state has their unique blend of taxes and exemptions.  It is very important that you know how this structure affects your farm operation and what you can do to prevent the imposition of more state taxes.

Extra Year for "Prairie Pothole States"

Jul 05, 2011

The USDA announced on Thursday, June 30, 2011 that the "Prairie Pothole States" of Montana, North and South Dakota, Minnesota and Iowa will have one extra year to use in their prevented planting insurance coverage.

Normally, the prevented planting coverage insurance requires one crop in the last three years. In these states, for many farmers, the last crop they had was in 2008. Thus, under the old rules, these farmers would have been unable to get this coverage next year.

However, USDA has changed the rules for these states to use one crop in the last four years instead of three years which will allow many farmers to use the 2008 crop year.

Check Your FUTA Wages!

Jul 04, 2011

I never thought I would write a post on FUTA (Federal Unemployment) taxes, but here I go.  The original FUTA tax rate was 6% with an up to 5.4% credit for taxes paid to your state.  Starting in 1976, Congress had tacked on a surtax of .2% for a gross FUTA rate of 6.2%.  This surtax had always been extended until now.  Effective July 1, 2011, the FUTA rate drops back to the old 6% rate.

This means that farmers will need to keep track of the wages paid before July 1 and after July 1 since the rate of tax will be different.  Also, form 940 will need to be revised for these different rates.  In the long-run, this is a reduction in tax, however, for 2011, more paperwork will be involved.

Remember, for farmers, you are required to pay FUTA tax if you meet one of the following two rules:

  1. You paid cash wages of $20,000 or more in any one quarter during this year or the previous year, or
  2. You employed as least 10 workers at least one day for any 20 weeks during this year or the previous year. 

 

If either of these two apply, then you must pay FUTA tax.

What's Your RLU?

Jul 01, 2011

A farm enterprise must be able to generate enough revenue and net income to support at least one farm family which I call a "living unit".  A farm operation should calculate how much revenue the farm generates each year and divide that both by the number of full-time equivalent employees (FTE) and "living units". 

To get the ratio of revenue to FTE is fairly easy.  You take the total revenue for the farm and divide it by the FTE on the farm.  If you have several part-time employees, you should add all of their hours together and divide by 2,080 to arrive at the FTE for them and then add it to your full-time employees.

Let's take an example:  Assume the farm has revenue of $2.5 million, has 4 full-time employees including the farm owner and hires part-time help that totals 4,160 hours for the year.  Take 4,160, divide by 2,080 and you get 2 FTE and add the 4 full-time employees equals 6 FTE.  $2.5 million divided by 6 equals $416,667.  It is more important to see what your trend in this number is each year and due to the large recent swings in prices, you may want to also calculate acres farmed by FTE to see what your production per FTE is.

To calculate revenue per living unit (RLU) is a little more complicated.  You first need to determine the amount of net income needed to support one average farm family.  You then determine what your average farm margin is before owner's salaries and benefits and  then divide the net income needed to support the family by this percentage.

Let's take an example:  Assume one average farm family requires $110,000 of  wages , benefits and taxes to support the family.  A review of the farm showed that the net contribution margin to the bottom line before overall owner's compensation and benefits was 15%.  $110,000 divided by 15% equals $733,333.  This means for this particular farm, it takes $733,333 to support each family unit employed on the farm.

What many farmers do not realize is how much revenue or acres is needed to support each additional farm living unit that they want to bring into the farm operation.  In the current case of a $2.5 million family farm, it probably could support 3 family units fairly well, however, if they elect to bring into another family member, the farm can not comfortably support 4 with their current revenues.  The farm would need to grow revenues from about $2.5 million to almost $3 million to support 4 family members.

It is important to know what this number is for your operation and what the trend has been, especially if you plan on bringing on more family members to help operate the farm.

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