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July 2013 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.

Evaluating the New Century Go-Go Farmer

Jul 31, 2013

Bob Craven, head of the Center of Farm Financial Management (FINPACK) for the University of Minnesota gave a discussion on evaluating the new century Go-Go farmer.

The Median income for 2012 for Minnesota farmers was a slightly less than $200 thousand, while the top 20% were almost $700 thousand of net income.

Top 20% characteristics:

  • Gross Income - $2 million
  • Assets - $5.6 million
  • Acres farmed - 1,943
  • Acres owned - 493

The bottom 20% of farmers grossing more than $1 million is net income of about $175,000, however, back in 2009, these same farmers lost about $212,000. Working capital dropped 8% in one year from about 14% to 6% and if the trend went one more year, they would be in a negative working capital situation.

The Go-Go Culture:

  • Hard Charging
  • Focused on Expansion
  • Willing to Take Risks
  • Gross Income is Close to Exceeding Gross Assets (everything is rented)

 

Liquidity is the first line of defense in this environment and collateral is second. Lenders would rather have the farmer cash flow then liquidate. The working capital to gross income is more reflective of the liquidity position than working capital.

Crop farms have built their working capital to gross income from about 25% to over 50%. Our crop farmers are very liquid while livestock farmers are still under about 20%.

The low-cost producer in Minnesota on cash rented ground is about $3.75 per bushel while the high cost producer was in the $5.70 per bushel range. What happens to these high cost producers when the spring price guarantee is $4. Will they be able to get a loan.

An example was a 10,000 acre Go-Go farmer with $5 million of net worth and about 15% of working capital. Assuming a normal 175 bushel yield with $6.25 price, the farmer would make about $800,000. However, if the price drops to $4.75 the profit drops to an $1.8 million loss and working capital is gone. This only takes one year.

The Perils of Benchmarking

Jul 31, 2013

The next two sessions at FFSC dealt with the perils of benchmarking. As farmers try to benchmark themselves against other comparable farm operations, it becomes readily apparent that many perils or issues can arise.

In many cases farmers (since they are human) really like using benchmarking when they are above average. In they are below average, many times they will try to make excuses as to why they are not above average, when they should key in on how to get above average.

We then had a panel discussion with three members that are actively involved with benchmarking. Much of the required benchmarking appears to come from financial institutiions requiring it for their ag clients. This applies to dairy, livestock and higher income crops such as orchards, vineyards and other related farm operations. It had not yet migrated to the corn belt crop production enterprises.

The key to benchmarking is:

  • Make sure to know your benchmarking trends for your own operation first. It is more important to know your own trends, then to simply compare yourself to others
  • Understand that the data you are benchmarking to may not be fully comparable, standardized or relevent.
  • Make sure you have enough years of data. One idea is to use five years under the Olympic method where you throw out the highest and lowest numbers for each ratio. This may give a better measurement.

One of the most difficult parts of benchmarking is where to draw the line on the type of farm operation to benchmark to. For example, on a dairy operation, do they only milk cows, do they raise all of their feed and replacement heifers or somewhere in between.

Benchmarking is great, but if you do not use it as a tool, it becomes worthless.

Don't let that happen.

The Farm Financial Standards Council - Part 1

Jul 31, 2013

he annual conference for the FFSC got started this morning with a presentation by Dr. Tom Gillaspy a retired Minnesota State Demographer. He led off the presentation by stating that demographers are even more boring than accountants. I was almost insulted by this comment until I decided to consider it a compliment since he was fairly exciting.

One key stat he mentioned is that our people coming into the workforce are at an all time low. Instead of the rule of thumb that 120,000 people need to added monthly to workforce to keep employment steady, the actual number now is closer to 90,000.

In addition, record numbers retired last year and this years pace is even greater.

Farmers age 45 and over have increased from about 35% of total farmers in 1978 to almost 60% now. This aging population is not being replaced by younger operators.

Although the US issue with an aging workforce is not good, it is even worse in Japan and Western Europe. China is younger than us, but in three years, they will be older than us and will start declining in population soon when India will surpass them in population.

Much of Latin America will have a birth rate lower than the United States so this trend will start to affect them. The only place in world with no drop in birth rates is sub-saharan Africa.

Although the presentation seemed a little gloomy at times, we are still in good shape.

The Bucking Combine

Jul 29, 2013

Friday and Saturday of last week I spent driving (or operating) my cousin's Case IH 2388. I got started around 1 pm on Friday. For that day, we had two machines running, an older 1470 and the newer 2388.

We were cutting on a field with slopes ranging from about 10 degrees to several in excess of 30 degrees. My cousin had reminded me that when traveling downhill you wanted to make sure the rear-wheel assist was off.

Well, I made it to the last part of day with no issues. They have their grain trucked by others and toward the end of the day, we realized the last load out would be around 6 pm.

I was about half way up a hill when I got a call from my cousin to come back to the truck and dump the load. Since this call was out of the blue, I simply turned the combine down the hill and started to make my turn. Again, this was probably on a 30 degree + slope.

As I got about half way through my turn the header and front end of the combine started to "buck" bouncing up and down by about a foot or so. I looked and saw that the creek/ditch at the bottom of the hill was about 20 to 30 feet away.

At that point, I jammed on the right brake to make sure the combine would finish the turn and missed the ditch by at least 10 feet. I then mosied to the bottom of the hill, dumped my load of grain and finished up the last load.

The last time I had a "bucking" combine when I was about 19 years old sliding down the hill on wheat mixed with cheat grass. This is probably an adrenaline rush that I can do without.

Tomorrow starts the first day of the annual meeting of the Farm Financial Standards Council. The meeting is in Minneapolis this year and tomorrow is primarily the meeting of the committees with the meat of the meeting on Wednesday. 

Will Crop Insurance Proceeds Be Deferrable This Year?

Jul 22, 2013

We have had a couple of posts on prevent plant crop insurance proceeds being deferrable into 2014, however, what happens if there are crop insurance proceeds at harvest time. Most likely, all or almost all of these proceeds will be related to a drop in price. For example, the Corn Spring price was $5.65. If the harvest price ends up around $4 most crop insurance proceeds will be directly related to the drop in price, not related to damage to crops. For corn prices to get this low, there would need to be a bumper crop (all farmer's crop production are different, so part of it might be related to yield loss).

The income tax laws allow you to defer crop insurance proceeds related to yield loss, but not price loss. Therefore, if a farmer receives crop insurance proceeds this year and their yield is greater than their APH, then most likely all of the crop insurance proceeds received in 2013 will be subject to tax this year and not deferrable till 2014. If their yield is lower than their APH and the harvest price is lower than the spring price, then part of the proceeds will be deferrable.

If the farmer deferred a large amount of crop insurance proceeds from 2012 into 2013 and has crop insurance proceeds in 2013 that they cannot defer, you may want to work with your crop insurance company to have them delay paying the proceeds until 2014.

It is a little early to be thinking about crop insurance proceeds while we are just getting started with pollination, but as we get closer to harvest, you need to be planning on when you want to report these proceeds, if any.

Therefore, the bottom line for 2013 is:

  • Prevent Plant Proceeds - Are deferrable if you meet the normal rules for deferring crop insurance proceeds
  • Proceeds related to the drop in price from Spring to Harvest - Not deferrable
  • Proceeds related to yield loss - Deferrable

 

How Long is Your Pickup Bed?

Jul 21, 2013

We had a reader ask the following questions about purchasing a new pick-up in 2013:

"The new 2014 Silverado pickup has a model with a 5' 8" (inside dimension) box. Can you take section 179 on the full amount of this pickup for the 2013 tax year?"

The Tax Code has a provision that does not allow a full Section 179 deduction for the purchase of a farm pickup if the pickup bed is less than six feet. In this case, since the 2014 Silverado pickup's bed is 5'8" long it would fall into this restriction and the taxpayer would only be allowed to take Section 179 on $25,000 of cost times the business percentage. However, since it is a new pickup, the remaining cost basis would be allowed for 50% bonus depreciation and then regular depreciation on the remaining cost basis.

Let's assume the cost of the Silverado pickup is $45,000. Assuming 100% business use, the taxpayer would be able to take Section 179 of $25,000, then 50% bonus depreciation of $10,000 and regular depreciation of $1,500 for a total deduction of $36,500. The remaining $8,500 of cost would be depreciated over the next five years.

Now, let's assume that he purchased a 2014 Silverado pickup with a box exceeding 6' in length. In this case, the farmer could take Section 179 on the full $45,000 cost.

If the pickup is used, then 50% bonus depreciation does not apply. In this case, if the bed is less than 6', the farmer can only take Section 179 of $25,000 plus regular depreciation of $3,000 for a total deduction of $28,000. If the bed is longer than 6', then the farmer may still take full Section 179 deduction of $45,000.

Unlike most farm equipment purchases, the purchase of a pickup in 2013 can result in additional tax complexities. If you are planning on purchasing a pickup this year and the box bed will be less than 6', you may want to discuss this with your tax advisor before making the purchase.

Capital Gains Questions on Selling Farmland

Jul 16, 2013

We had a reader ask the following series of questions.  We are going to break them down into a question and answer format.

Q - Regarding capital gain rates and selling farmland - Am I correct to use the difference between a stepped up ( appraisal / time of death ) value of inherited farmland and sale price ( long term )

A - When you inherited land, you will use the basis that the estate placed on the land at the time of death.  However, in some cases, this value may be different if the land was originally in a trust for the benefit of the person who died and it did not get included in their estate.  As an example, assume Grandpa owned 500 acres of land and passed away in 1970 when the value of the land was $50,000.  This property was placed in a trust for the benefit of his only son until his death in 2013 when the land was worth $5 million.  Under the terms of the trust, the land is then distributed to the son's children and they elect to sell it for $5 million.  Even though it was worth $5 million when the son died, the heirs have to use the $50,000 cost basis since this land was not included in the son's estate.

Q -If so, when I subtract the difference between cost basis and sale price may I deduct broker fees ?

A - All broker's fees, commissions, title insurance and any other related costs of the sale are allowed as a reduction of the gain.

Q - In addition what is the rate I pay as a non resident to the state of Illinois ?

A - For most states, there is no special reduction in the capital gains rates for sale of farmland.  Therefore, for most states this income is treated like other income and subject to the same income tax bracket.  However, some states, assuming you meet certain specifications allow you to reduce or eliminate the gain from the sale of farmland.  You would need to check with your state laws to see if that is applicable in your situation.

Q -  Do I pay 15 % cap gain to both the state and the Federal government ?

A - This answer like many income tax questions is "It depends".  We previously stated that the state capital gains rate is most likely the same as your other state income tax rate.  The federal rate is only 15% up to the threshold amount ($200/$250K), then the extra 3.8% net income income tax kicks in which increases your rate to 18.8%, then certain phase-outs may increase it another 3-6% or more.  Finally, if the gain is large enough, the capital gains rate will increase to 20% plus 3.8% plus any related phase-out increases.

Q - Is one deducible from the other ?

A - The state capital gains tax paid is usually deductible on the federal return.  However, in many cases, the Alternative Minimum Tax (AMT) will make this deduction have no value assuming the taxpayer ends up in AMT.  AMT does not allow a deduction for state income taxes.

Some states allow a deduction for federal tax paid, however, there is usually a limit on the amount of the deduction.

Q - Finally what level of income bracket results ( if any ) in a lower or 0 % cap gain ?

The 0% capital gains tax rete applies to the amount of capital gains that is taxed in the 15% or lower tax bracket.  The cut-off for a married couple in 2013 is about $72,000 of taxable income.  A taxpayer would calculate all of their other ordinary income after deductions and if this amount is less than $72,000, then the difference would be the maximum amount of capital gains that could be taxed at zero.

For example, assume a couple has ordinary income after all deductions of $30,000.  They have a gain from selling farmland of $200,000.  $42,000 of the gain would be taxed at zero percent ($72,000-$30,000) and the remainder would be taxed at 15%.  However, all of the gain would be subject to their regular state income tax rate (unless they meet certain farmland sale limitations).

Watch Out For Disregarded Entities When a Member Dies

Jul 14, 2013

Limited liability companies (LLC’s) are often a preferred entity choice for small businesses, farm operations, and rentals because they offer some liability protection for owners. Generally, LLC’s are treated as partnerships for tax purposes, and a Form 1065 partnership income tax return is required to be filed.

In community property states, when a husband and wife are the sole members in an LLC, the activity of the LLC can be reported on the married couple’s Form 1040 federal individual income tax return. In this case, the LLC is considered a disregarded entity, and no partnership return is required to be filed.

A potential problem may arise when a couple has reported the farming, business, or rental income from a disregarded LLC on their individual income tax return and then one spouse dies. When the spouse’s estate or a trust is a member in the LLC, a partnership return may be required.

For example, Frank and Mabel have two LLC’s that are owned 50% by each spouse. One LLC holds farmland and the other one is where the farming operations are done. While both spouses were alive, the farmland rental was reported on Schedule E, and the farm income was reported on Schedule F of their Form 1040 individual income tax return. But, when Mabel died, both LLC’s are no longer disregarded entities. Rather than husband and wife, the members of the LLC at the date of death are now Frank and Mabel’s estate.

To make matters worse, often in the year of death, individual income tax returns need to be extended while the estate is settled or the surviving spouse takes over the recordkeeping. You must be careful to recognize when you are in this situation, or you may not make a timely extension of the partnership returns which are now due. In Frank and Mabel’s case, they would likely be exposed to a penalty to the tune of $195 per-month after the April 15th due date, per partner. Frank, Mabel, and Mabel’s estate would each receive K-1’s from each LLC, so if they didn’t realize their filing requirement until August, they would be exposed to $4,680 ($195 x 3 partners during the year x 4 months x 2 late returns) of penalties!

If you and your spouse have a disregarded LLC, this would be a very good item to talk to your tax advisor about and to add to your survivor’s checklist as part of your estate plan!

Top Farmer, Day 2 - Last Session

Jul 10, 2013

The final session of the day was presented by Marcos Fava Neves of the University of Sao Paulo, Brazil on the Brazilian Agriculture Perspective.

Marcos is based near Sao Paulo which does not have much soybean or corn production in the area.  Rather, they are in the heart of sugar cane country and Ethanol plants.  Marcos has published a book called "The Future of the Food Business" which has been published in English and Chinese.

An interesting slide of China imports shows about $30 billion of grains and about $55 of total agriculture imports.  this is up from $5 billion 10 years ago or an 11 fold increase.

He predicts that we will be talking about India 5 years from now instead of China.  Their current population growth is out of control.  In 15 years they will add the current population of the United States.  They will pass up China in population soon.

There was another graph showing the GDP growth rate over the next 40 years.  Surprisingly, the highest average growth country will be Nigeria at about 6% per year.  China is at 4.5%, while Brazil is a little bit lower (but importantly to Marcos, it is higher than Argentina).

The largest importers of Ag products currently is Africa, not China or Asia.

About 40% of Brazil's exports are Ag based.  Grain production is about 185 million tons up from about 100 million tons 10 years ago.  Ag is about the only thing performing real.

Soybean exports are about $26 billion, meat at $16 billion, sugarcane at $15 billion, while corn is about $5 billion, however, this is a 100% increase over the previous year.  Total Ag exports are about $100 billion.

Europe and US represent 34% of the imports purchased down from over 60% ten years ago.

There are three types of farm operations in the country now.  The traditional farmer owns and operates the farms.  The second type owns, farms and then processes the land.  The last group coordinates the input process with a farmer or a simply a manager of the farming process.

SLC Agricola Business is publicly traded and farms about 750,000 acres and soon will be at 1,000,000 acres.  Their production is better than US averages by about 10% for this company.

Top Farmer, Day 2, - Session 3

Jul 10, 2013

The next session was presented by Jason Henderson who just started with Purdue after being with the Federal Reserve Bank of Kansas City.

He presented a series of maps showing farmland values from 1900 to the 1980s using constant current dollars.  In 1900, there were no counties that had average farmland values exceeding $3,000.  Some counties went over this mark during the 1910s and 1950s and 1960s, but it was not until the 1970s that almost all counties exceeded this level.

This caused the "wealth effect" to hit farmers leading them to increasing investment in additional land and machinery, not using income, but rather the wealth they had accumulated.  Well, we know what happened in the 1980s to this wealth.  It basically disappeared.

Jason is concerned that if current high farmland values continue for another two or three years that farmers will use their current wealth to fund asset purchases instead of cash flows.  This could lead to a duplication of the 1980s but we are long ways from that scenario, but caution is warranted.

Top Farmer - Day 2 Session 2

Jul 10, 2013

My next recap is in regards to the "Crop Markets in Transition" presented by Darrel Good of the University of Illinois. 

Darrel noted that there is the potential for a 14 billion bushel crop with added production in South America, it may be tough to meet the export estimates by USDA.  Ethanol consumption should pick up by about 350 million bushels.  Feed and residual is expected to jump by a large amount due to the large size of the crop (i.e. this is the plug number).

Ending stocks of corn can easily hit 2 billion bushels (again assuming weather cooperates).  Since current future prices for new crop corn is under the spring price set for crop insurance, Darrel has recommended not making many new crop sales (assuming the farmer has crop insurance).

Regarding soybeans, Darrel noted that the final soybean numbers have a greater variability due to the late planting of the crop.  If there is an early frost, then the crop may be near the 3 billion bushel level.  If tread line yield is achieved, then the crop will most likely be nearer 3.4 billion or so.

It appears that the average soybean price going forward should trend between $9 and $13 for an $11 average.   This will occur when the supply shock of the last couple of years wears off.

Chris Hurt of Purdue University then presented an outlook on the world supply and demand outlook.  The world total acres of the major crops hit a new record of 2.288 billion acres.  Over the last 7 years we have added 147 million acres into production.  Ofthe increase about a third is in South America, the Former Soviet union add about 20%, East Asia and North America about 15%, withthe other increases spread over the world.

The trends for world stocks as a percent of use is as follows:

  • Corn - 27.3% up from about 22% this year
  • Beans - 16.2% up from 14.4% this year
  • Wheat - 26.1% slightly lower than last year
  • Rice - 22.6% up slightly from last year

 

This means that there should be no excessive supplies. 

US net farm income was about $118 billion in 2011, $113 in 2012 and is expected to be $128 billion in 2013.  Corn revenue inlcuding crop insurance payments were $66 billion in 2010, $80 billion in 2011 and a record $88 billionin 2012 even with the drought.  Total revenue for 2013 are expected to drop by $15 billion even though the crop may be at least $2 billion larger.

Average quality Indiana farmland returns over the last five years were a low of $136/acre in 2009 and peaked in 2011 at $357.  While lower in 2013, the expectation is per acre returns of $285 with a possible drop back to $210 in 2016.

Top Farmer Day 2 - Session 1

Jul 10, 2013

Since I have my laptop with me today, I am going to try to do a separate post on each session for today's Top Farmer Conference.  Yesterday's sessions were very informative and I hope today is even better.

First session today is an update on Ethanol and Bio-Diesel production presented Scott Irwin of the University of Illinois.

The Renewable Fuel Standards (RFS) have various required minimums of renewable fuel production between now and 2022.  Ethanol has just about met its required minimum of about 15 billion gallons.  The interesting requirement that Cellulosic production will be at least 15 billion gallons by 2022. current production is not much.  Bio-diesel minimum is about 5 billion gallons by 2022.

The big growth in the Ethanol industry in the US is over (unless 15% ethanol blends get more traction).   For 2013, the mandate for Cellulosic Ethanol is 1 billion gallons and current production is about 14 million gallons.  The technology has not caught up with the mandate.

The current Ethanol blend wall has limited ethanol blends in gasoline to about 10%.  E15 is available, however, if the infrastructure is not in place.  As of 2013, the mandate for Ethanol is about 13.8 billion gallons, but the blend wall is about 13 billion gallons which will remain the same going forward.  By 2015, we are supposed to be at 15 billion gallons of ethanol, but there is only 13 billion gallons that can be reasonably used.  This is starting to create a problem.  The gap for 2013 of about 800 million gallons can be used to meet the Bio-Diesel gap for this year.

The supply and demand laws reflects this now since the price of an Ethanol and Bio-Diesel RINs are now about equal.  Last year, the value of an Ethanol RIN was about a dime and the Bio-Diesel RIN was over a dollar.  The value of both are now about 80 cents or so.

E15 is available in about 20 gas stations in the US (out of about 120,000 total stations).  E85 may make up the difference since there is about 11 million flex fuel vehicles.  These vehicles do not count against the CAFE fuel standards and that is the primary reason for the high numbers of flex fuel vehicles.  However, the price of E85 fuel should be priced at about 77% of normal gasoline to equal the fuel value of gasoline.  For the last three years, the price of E85 has not gone below the breakeven level, therefore, the use of E85 has not helped much.  Only 3,000 gas stations offer E85.

The bottom line is that the growth of Ethanol production will slow dramatically starting this year unless the EPA changes the standards to allow more Ethanol to meet the Cellulosic standards.  Otherwise, American corn farmers have met the "Wall".

First Full Day of Top Farmer

Jul 09, 2013

Today was the first full day of the Top Farmer conference and it was packed with a lot of good sessions.  Due to finding out that I had to get something done early this morning, I missed the most of the morning session, but here are my highlights from the rest of the day.

  • Right before lunch was an interesting recap of the profits earned by corn growers around the world.  Although many countries yields are not as good as the US,their cost structure, in many cases is much lower than ours.  For example, Russia's yields and prices are about half of ours, but their profit for 2012 was much higher since their cost structure is much lower.  It becomes very apparent how Argentina's export tax and low prices affect their corn farmers.  Their yields are close to ours, their costs are much lower, however, they barely break-even due to the government taxes and restrictions.
  • We then had a discussion on the value of adding organic material to the soil.  A local farmer described their efforts over the last 20 years to add organic material by using cover crops and no-till.  Based on his analysis, he believes this has added about $150 of value to his margin each year.
  • My next session was on the using the spreadsheet tools available from the FarmDoc crew at the University of Illinois.  I have posted on their site several times and we used the crop budget spreadsheet to estimate the income for a 2013 farmer under various situations.  For a 2,000 acre farmer who did not use crop insurance, having a bad yield and price resulted in a $600,000 loss.  Farmers with crop insurance for 2013 have most likely locked in a profit, but 2014 will be the wild card.
  • Bernie Evern from Ohio State University then gave a discussion the power of a good interview by farmers.   The effective use of the interview process leads to finding good people who will stick with you for a long-time.  The ineffective use will result in high turnover and extra costs.  It is more important to ask questions about what the job applicant has done in the past, then what he might do in the future.  Too many applicants tell you what you want to hear based on their observations before and during the interview.  It is your job to not let this sway your decision.
  • Last, we went out into field and had a discussion on the use of variable applications of fertilizer using infrared technology, etc.  Our human eye assumes that when a corn plant is deep green it has plenty of nitrogen.  The use of sensors in many cases will prove otherwise.  This technology is still evolving and may not quite yet have an appropriate pay-out based on the investment.

 

We finished up at a local restaurant and had three undergraduates fill us in on their experiences in a new class offered by Purdue.  This class involved visiting various farms and agribusinesses in the area and their feedback was very informative.  Based on these students, I think the Ag industry is in good shape for the future.  Many great students are enrolled in Ag and we need them.

That is all for today and I will update after tomorrow's last day.

Employer Mandate Postponed for a Year

Jul 02, 2013

One of the major initiatives of ObamaCare was the mandate for employers to either provide health insurance or face possible extremely steep penalties for not providing health insurance or providing insurance that was too costly.  This mandate was to take place starting January 1, 2014.  The mandate applied to employers with 50 full-time equivalent employees.  For most of our farmers, this law would not apply, however many of our orchards, vineyard and related operations may have been dramatically affected by this mandate.

Well, this mandate has been postponed for at least one more year.  It will not start until 2015 and I am sure that is has nothing to do with 2014 being an election year.  We may start to see even more ObamaCare provisions being postponed or eliminated over the next few months.  One of the primary features is the creation of state-run health insurance exchanges and you are probably aware that most of the states are not up and running yet and they need to be ready beginning October 1, 2013.

It will be interesting over the next few months how this turns out and we will keep you posted.

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