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October 2010 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.

How to Transfer Equipment to Multiple Parties

Oct 28, 2010

One of our readers had the following question:

"I am slowing down farming. understand can gift 13000 a year in machinery value each to my son, his wife and his son.  What records and paper work do I need for this? Do I need equipment appraised? Does this allow me to take this equipment off my equipment schedule and not pay any taxes on it? Also my son wants to buy, rent, or lease some of my other depreciated equipment. What is the best way to handle this and paperwork to back it up beings he is my son? Also my son wants to buy,rent, or lease some other depreciated equipment. What is the best way to handle this? . Anything extra because of his relation as far prices?"

 

A gift of one piece of equipment to one person is fairly easy to do.  You simply transfer the equipment to the person, change the title (if there is title) and the equipment is now in the hands of the new person.  Normally, you do not need to get an appraisal, however, if the equipment is fairly new and the is a combine, tractor, drill, etc. it would make sense to get an equipment appraisal.  If the value exceeds $13,000, you are required to file a gift tax return, however, you can gift up to $1 million during your lifetime (above the annual exclusion of $13,000) tax-free.

Now, when you want to start gifting multiple pieces of equipment to multiple parties, I would suggest that you create a new LLC or S corporation to own this equipment.  The transfer of the equipment to the LLC is normally tax-free and the same with a corporation (unless your liabilities on the equipment exceed your basis, then you will have some taxable gain).

After the transfer is down (and if you are married, I would normally have half in your spouse's name also), you can then transfer LLC units or stock in the corporation to your children and grandchildren.  Another benefit of this structure, is that the gift is usually discounted by about 35% or so due to a transfer of a minority interest in a LLC versus the direct transfer of equipment.

Once this transfer is done, the LLC will then rent the equipment to your son to use in his farming operation.  If you structure the LLC properly, you should be able to minimize the self-employment tax by having your son be the active manager of the LLC (with say 1% manager ownership interest) and having other other 99% being owned by you, your spouse, son, grandchildren, etc.   These interests are not usually subject to self-employments taxes, if structured properly (this planning is based upon a proposed IRS regulation that was never finalized, so some tax advisors may not be totally comfortable with this type of structure).

I will probably do another couple posts related to this question in the next week or so to update some of the conclusions with more details, but this is an over view of how to handle these types of transactions.

Can a Farmer Elect to Not Report Expenses?

Oct 27, 2010

We got a question from a reader today asking if you they are required to report a deduction on their income tax return.  I would normally post a copy of the question here, but the details associated with this question makes that impractical.

In brief, the farmer originally reported $2,000 of interest expense as interest income by mistake and when they got the return back from the CPA and reviewed it, they caught the error and prepared an amended tax return to correct the error.  However, when they got the amended tax return back from the CPA, they expected their gross income to decrease by $4,000 and it only went down by $2,000 since the interest expense was reported on form 4835, farm rental income.  They had net passive losses, so the actual interest expense of $2,000 does not get deducted in the current year, but gets carried forward.

They had an interesting question regarding are you required to report this expense on their return.  Generally, you are required to report all income and expenses associated with your farm operation.  However, you have some lee-way in whether you have to deduct the expense.  In some cases, such as repairs, taxes, interest, etc., you can elect to capitalize these items and either amortize or depreciate over a longer period.  In other cases, you can make an argument that part of the expense is of a personal nature and not deduct that portion.  Also, by capitalizing repairs, this gives you the option to take Section 179 expense of whatever amount you want to maximize your refund.

You are probably asking why would you not want to deduct an expense.  There are several times when you would not want to:

  • Lets say you have a couple of kids and your income for this year is not very high.  By capitalizing certain items and depreciating them, you would be able to go from not getting any earned income tax credit to perhaps getting $5,000 or more just by setting these items up on the depreciation schedule.
  • You may want to take advantage of the 15% or other low income tax brackets by getting your income up to that level, so your income for the next year would not go over that level.

Here is a quick example of how this works.  Say we have a farmer who has net farm income of $35,000 before deducting a large repair of $35,000.   If they deducted the repair in full, they would owe no tax, however, they would get no refund back either.  If they capitalize the repair and elect to take Section 179 expense of lets say $7,500, they will still not owe any tax, however, they now get an earned income tax credit of $5,000 as a tax refund.

You must be careful to not simply ignore the expense on the return since the IRS, on audit, can report the expense and reduce your tax refund if you were trying to manipulate the earned income tax credit.

Feed Your Harvest Crew and Deduct It!

Oct 26, 2010

We got this question from one of our readers and it would apply to almost any farmer who hires a harvest or planting crew:

"Hi Paul, I was wondering how taxes work on food bought for workers. On our family farm we have a couple part time hired hands who work 200-300 hours a year between planting and harvesting. When working my mother feeds them quite well. Big lunches, dinners, sodas, cookies, deserts, etc. I was wondering if these food purchases are tax deductible? Also, do you know of any good farm tax resources for me to study so I could get a better idea of taxes in relation to farming."

Normally, meals are deductible to an employer at 50% of the cost of the meals.  However, in this case, where the meals are provided to the employee on the employer's work site and for the convenience of the employer, the meals are completely 100% deductible by the employer and the employee does not have to pick up any of it as income.

The rationale behind this is that the harvest crew does not have time to run into town to get a meal and it is more productive for the farmer to provide the meals directly on site and get the job done.  Therefore, the tax laws allow the farmer to deduct the meals in full.

Farm Exports May Hit a Record in 2010/11

Oct 25, 2010

I just read an article in the most recent issue of BloombergBusinessWeek magazine that had some interesting facts and comments. 

First, for the first 8 months of 2010, farm exports are up by 14% to about $ 70 billion and this is before the recent increase in prices.

Second, it is estimated that China will become the second largest importer of our ag goods with $15 billion in 2011 second only to Canada's $16.8 and slightly ahead of Mexico at $14.6 billion.

I am not sure if their math is correct since they say Ag is only 1% of our $14.3 trillion dollar economy which would be about $143 billion.  Our corn sales alone would be about $65 billion, so I am not sure if I agree with the math, but they do indicate if you include farm equipment sales, inputs, food processing, etc., the actual impact may be about 10 times higher or over $1 trillion in sales.

Tom Neher, vice president of AgStar Financial says their bank has issued twice as much farm equipment loans as expected in a recent promotion.  "I've seen more brand-new combines bought that I've seen for a long, long time", says Neher, who helps manage $2.1 billion in grain-related loans and leases for AgStar.

That is also one of the prime reasons for BHP to try to buy Potash Corp.

When is a Deposit Income - Part 2

Oct 25, 2010

In response to our post on when is a deposit income, we had a reader write in the following:

"In regard to today’s blog: I have a tenant who , over the years, mails his rent that is due Jan 1 in the previous Dec. Obviously he is deducting the rent as a "prepay". I always deposit the check in Jan and count it in that year’s income. If one of us is audited, which one of us will get the penalty?"

As usual with tax law, the answer to this question is "It Depends'.  Actually, unless the tenant and the landlord are related parties, neither party will be at risk with regards to an audit.

A cash basis taxpayer can write and mail a check by December 31 and be able to deduct the payment in that year.  If the landlord receives the check in the next year, it is income in that year.  You want to be careful to document this if the check is dated too soon the previous year.  For example a check dated the 29th to the 31st would probably be OK, if it is dated the 25th or sooner, you might have some issues on an audit, but as long as you document when you receive it, you should be fine.

If the tenant and landlord are related parties, then the tenant is not able to deduct the check until the landlord picks up the check as income.  Related parties are usually family members or entities controlled by the same people.  For example, if a corporation which is owned by a farmer, writes a rent check to the farmer for their land rent, the check is not deductible until the farmer reports it as income.

 

 

Investors Worry About Accuracy of USDA Reports!

Oct 22, 2010

In Friday's Wall Street Journal, there is a front page article in the Money and Investing Section regarding the worry of various investors about how accurate the USDA has been with the latest US corn crop.  As most farmers know there has been whipsaws in the reports issued this year.

In June, the USDA reported that stockpiles were lower than expected and prices jumped 9%.  In September, the USDA reported a more than expected increase in carry-over by 300 million bushels and then a few weeks later reported the actual 2010 corn crop was going to be substantially lower than expected which resulted in much lower carry-over than the trade expected.  This resulted in a dramatic increase in prices.

The USDA's reporting problems will probably be a topic of conversation when agency officials gather for their annual data user's meeting in Chicago on Monday.  I would like to be an invisible participant in that meeting!

The USDA indicated they had a hard time estimating the average weight of the corn kernel, which led to the USDA reducing their estimate twice since indicating a record crop in August.

Some analysts cut the USDA some slack by stating this year's crop was a unique set of circumstances related to weather and unlikely to see again  (however, that is what they always seem to say about 100 year floods that happen every 10 years or so).

As we stated in a previous post, volatile times are here and USDA reports may make it even more volatile.

Can I Defer Taxes on Equipment Sales?

Oct 22, 2010

We got the following question from one of our readers:

"I'm downsizing and want to sell some of my depreciated equipment. If I sell it out right I will pay full tax the first year on sale price. Can I lease my Equipment to someone for five to ten years to have the income spread over more years."

 

This is one of those good news/bad news answers.

First, on equipment sales, you generally taxed on the full gain in the year that you sell the equipment even if you sell it on a contract over a few years.  The only way you could defer this type of gain would be on the portion of gain which greater than the original cost of the equipment.  Generally most used equipment is sold for a price less than what the farmer paid for it, so this would not apply.

The good news is that you can defer this tax by renting the equipment to the new farmer.  You would report the rents as income and deduct any remaining depreciation that you can take on the equipment.

The bad news is that this net income is also subject to self-employment taxes in addition to normal income taxes.  This increases your possible tax rate about 15%.  However, if you are still farming and are already over the maximum wage base of about $107,000, then the extra net tax is only about an extra 2.5%.

Or if you own the equipment in a corporation and lease it out, you would not be subject to any additional self-employment taxes.  Another possibility is to use a LLC to rent out the equipment.

So, in conclusion, you can defer the tax by renting out the equipment, however, it may be at a higher rate.

Volatility - Is it Your Friend or Enemy?!

Oct 22, 2010

Another nugget of information that I got out of the speech by Dr. Boehlje of Purdue University on Wednesday is that accordingto their studies at the school, the volatility associated with agriculture has gone up by 400% in the last few years. 

This means that the price swings in ag commodities is now 4 times greater than it used to be.   I can still remember when I used to trade ag commodities on the futures exchange (many years ago) that a price move in corn of 3 to 5 cents was a huge move.  Now, 10 to 20 cents is almost the norm.

Dr. Boehlje also indicated that the volatility is not just in the sales price, but also the price that farmers pay for inputs such as fertilizer, seed and diesel.  Just in the last two years, we have seen fertilizer prices zoom up to about $1,000 per ton, back down to about $300 per ton and probably now around $700 per ton.

How does all of this volatility affect our farmers.  Dr. Boehlje indicates that great farmers view these times as a great opportunity to expand their operation and make it more efficient.  It requires them to take maximum advantage of marketing skills, financial reporting, and banking relationships.  It allows them to lock in great prices and also lock in their input costs.  Even if input costs go up by 50% or more, the increase in prices allow them to lock in a contribution margin larger than they can get now.  However, this requires them to know what their actual cost of operations are down to the bushel and acre level and they have a great relationship with their bankers.

The key question is where do you fall in this spectrum?  Do you view this volatility as an opportunity or does is worry you.  I hope you are in the former's viewpoint.

Lock in Low Rates Now

Oct 21, 2010

Dr. Michael Boehlje, a farm economics professor at Purdue University spoke at out opening day of the National Ag conference of the American Institute of Certified Public Accountants (I know that is a mouthful).  He gave a 4 plus hour presentation on the agricultural economy both currently and insights into the future.

One of the insights that he had was that current interest rates are at almost an all-time low.  The normal yield curve currently has a dip in rates between the three to seven year maturity before it steepens out to the normal curve.  He indicated that this presents a great current opportunity to lock in great rates in that three to seven year period.

He also indicated that it is much tougher to lock in low rates as compared to about a year ago due to the futures markets already pricing in higher rates beginning next year.  For example, he presented a chart showing the projected 3 month LIBOR rate (which a lot of banks use to set interest rates).  That rate is currently about .2%, however, the futures market is projecting this rate would be as follows:

  • 2011 - 1% or so
  • 2012 - 2% or so
  • 2013 - 3% or so
  • 2014 - 4% or so
  • Beyond 2015 it trends up to about 5%

 

This means that banks are not willing to lock in rates beyond a three to five period at a rate much lower than the expected LIBOR rate plus their normal spread of 200 to 300 basis points.

When is a Deposit Income?

Oct 20, 2010

I will be at the annual American Institute of Certified Public Accountants Ag Convention in Denver today till Friday.  I hope to come away some ideas for our farmers.

We had a reader ask the following question:

"Can you hold checks that have been sent to us for grain sold in 2010 until 2011?"

The technical answer to this is that these checks will be considered income for 2010 even if they are not deposited until 2011.  Even if a farmer is on the cash basis of accounting, any constructive receipt of funds is considered to be income in the year available to farmers.  Constructive Receipt is defined as any income, although not actually in the farmer's possession, which is:

  1. It is credited to the farmer's account,
  2. Set apart for the farmer,
  3. Made available so the farmer can draw upon it at any time, or
  4. The farmer can draw upon if it notice of intent to withdraw is given.

 

In this case, the farmer has constructive receipt of the income since they can deposit into the bank at any time.

In my state of Washington, we have several thousand farmers who have their fruit processed at the local packing house.  Each variety of fruit is received, packed and then sold.  After this process is complete, the packing house will then close out the "pool" and allocate the income and expense to each of the growers in the pool.  Once the process is completed and the posting of the net income is made to the grower's account, this net income becomes income to the farmer even though they have not received any cash.  This is due to the fact that the pool closing has been (1) credited to the farmer, (2) set apart on the grower's account statement, and (3) the farmer can draw upon the funds at any time with a notice to the packing warehouse.

A farmer can defer grain income into future years by entering into a contract, but I will leave that for a future post.

National Cotton Council Responds to Washington Post

Oct 19, 2010

I was doing some research on how high cotton prices have gotten in the last month or so.  Recently, the Wall Street Journal had an article stating that cotton prices were now the highest since the Civil War.  However, if you take inflation into account, prices are actually still very much lower than what they would have been 20 or 30 years ago at their high.

I did come across a post by the National Cotton Council regarding an article in the Washington Post labeled "Cotton Candy" (you may need to register to get access to the article).  The Post article described a lavish payout that was actually for relief for cotton farmers in 2009 that were unable to harvest a normal crop.

Also, the Post article indicated that the America controls 80% of the worlds cotton market.  The Council indicated that we only 16 percent of the overall crop and about 3% of the mil use.

There sometimes can be some very biased articles out there on our farmers and it is nice to see our trade organizations standing up for us.

For a copy of the National Cotton Council response, click here.

How to Allocate Your Land Purchase to Maximize Tax Savings?

Oct 17, 2010

We received the following questing regarding our post on the allocation of land purchase to vineyard AVA:

"Paul, You cover depreciating improvements on land. I am buying 150 acres in north-central Iowa that is bare ground. It has two county main tile lines running through it, has a blacktop road on one side and a gravel road on another. I am paying $705,000 for the farm. 15 acres are in CRP because they are wet. What percentage can you typically deduct for roads, tile, etc?"

When you purchase 150 acres of farm land, you are, as in this case, actually purchasing many components that need cost allocated to.  In this case, the farmer is buying:

  • 135 acres of productive farm land,
  • 15 acres of CRP,
  • Tile lines,
  • A gravel road, and
  • Probably some fencing.

To allocate this properly, you need to determine the reasonable fair market values of all of these items and then allocate the purchase price accordingly.  Fair market value for roads, tile line, fences should be based on what a reasonable third party would pay for the improvements, not the original cost.  For example, if it costs $700 per acre to put in the tile system and it is about 5 years old, you may want to assume a reasonable buyer would pay about $300-$500 per acre, not the $700 per acre of cost.

After determining all of these fair market values, you need to then allocate the purchase price based upon the percentage of fair market value for each item to the total fair market value times the actual purchase price.

Lets assume the following fair market values for each item:

  • 135 acres of productive land at $4,500 per acre or $607,500,
  • 15 acres of CRP at $2,000 per acre or $30,000,
  • Tile lines at $500 per acre or $67,500,
  • Gravel road of $20,000, and
  • Fencing of $15,000.

If you add all of these values together, you obtain a total fair market value of $740,000.  If we take each component and allocate purchase price based upon their related % to the total fair market value, we would get allocated purchase price as follows:

  • 135 acres of productive land  - $578,768,
  • 15 acres of CRP - $28,581,
  • Tile lines - $64,307,
  • Gravel road - $19,054, and
  • Fencing - $14,290.

If you add all of these values up, you get the purchase price of $705,000.  Since the tile, roads and fencing can be depreciated over 15 years, you have taken about $100,000 of the total purchase price and created a tax deduction versus treating all of the purchase as land.  In this case, that percentage would be about 15%, but every farm purchase will have their own unique situation.

Creative Farmer Gets Denied by IRS

Oct 15, 2010

Many farmers forget to properly allocated their purchase price when purchasing land.  For tax purposes, you can not deduct land, however, you can depreciate any improvements made to the land.  For example, assume a farmer buyer a quarter section for $1 million dollars.  On that quarter section, there is a well, roads, fences, buried main line, a small shed, and a grain bin.

The farmer is allowed to determine the fair market value of all of these items and allocate the purchase price accordingly.  By making a proper allocation, the farmer may be able to turn non-deductible land into depreciable assets.

In a recent IRS Chief Counsel Advice opinion, a farmer got creative with this allocation and the IRS turned them down.  The farmer had purchased a vineyard located in an area designated under the American Viticultural Area (AVA).  This designation can have great value to a vineyard since certain AVA appear to have a greater value to the consumer.  For example a Napa Valley AVA wine may be perceived to be more valuable that a wine from Central California, etc.

In my state of Washington, we have several AVA and for example, wines from the Walla Walla or Red Mountain AVA are perceived to be more valuable.

This farmer wanted to take advantage of the AVA and allocated part of the purchase price of the land to the perceived AVA value.  The amount allocated to the AVA, if allowed, would be deductible on a straight-line basis over 15 years.  Instead, the IRS said that this value could not be separated from the land and therefore is treated as part of the cost of the land and non-deductible.

This is the interpretation by the IRS for now, however, it would not surprise me to see this taken to court to determine if the IRS is correct.  I can see a valid reason for determining that there is extra value associated with an AVA and we shall see how this turns out.

But for now, you can not amortize an value associated with an AVA

Cost Basis Now Reported on Form 1099-B

Oct 14, 2010

Back in 2008 a new law was passed requiring banks and brokerage companies to report the cost basis of stocks, bonds, etc. sold during the year.  This reporting is to start for purchases after December 31, 2010.

The IRS has now released regulations that this cost basis information will be reported on form 1099-B which is logical since the sales information is already reported on this form.  As a CPA, I am actually looking forward to getting this information.

We  probably spend more time trying to get cost basis information on sales of stocks and bonds during the year than acquiring any other data.  Also, our office probably gets 20 or more letters from our clients that the IRS has sent them saying they owe tax due to stock sales.  In  some cases the proposed tax owed could be $100,000 or more.   What the IRS assumes on any stock sale that is not reported on your income tax return is that your cost basis is zero and you held it for less than a year.

This means the client might have sold a bunch of stock where the gross sales price was $300,000, the cost basis was $300,001 and the client thought they did not have to worry about it since they broke even.  Now, a year later, they get a letter from the IRS saying they owe $125,000 in tax.  These are usually fairly easy letters to write back to the IRS and explain, but it requires getting the actual information and in a lot of cases preparing an amended tax return.  This creates confusion for the client, extra fees to handle the letter and dealing with the IRS that can take more than 6 months to get a response from.

With the new rules, the sales price and cost basis will be incorporated in the same form and therefore, the IRS should be able to calculate the gain or loss not originally reported on the return.  Congress expects this reporting requirement to raise several billions in new revenue.  I actually think it was not raise much at all since they are already getting a bunch of money from taxpayers who simply pay the IRS when they get these letters since they assume the IRS is "right".

Dynamic Live Budget - Update

Oct 13, 2010

I have gotten a few requests on if there is software out there that will handle a dynamic live budget for farmers. 

What I have found so far that works the best is to use an Excel spreadsheet.  I have reviewed a couple of budgeting programs that are for me simply to complicated to work very well.  Quickbooks has a fairly good budgeting feature (along with most other accounting packages).  You can use these accounting programs to work up your budget, export it into an Excel spreadsheet and then set up your formulas for projected changes to the balance sheet and statement of cash flows.

The key area that is normally not addressed in an accounting software budget is the changes to the balance sheet and cash flow statement.  These changes are almost as important or more important than the profit and loss statement.  Only by incorporating all three statements will you get a dynamic live budget.

I have prepared these budgets for some of my clients in the past.  I will work on creating a sample budget for a corn and bean operation that will provide quarterly information going out for a two year period.  This would be an example of how the dynamic live budget will work.

Since I am busy with getting those pesky last minute extensions done and will be out of the office all next week on business, I may not get it finished until the last week in October, but when it is done, I will post it to our site.

Dynamic Live Budgeting - Use it to Prosper!

Oct 12, 2010

I see way too many farmers and other business people who treat their annual budget as the necessary evil that the banker requires at year-end to get the loan.  A very successful farmer will, rather, treat a budget as a dynamic live tool that will help guide their operation to maximize profits.

First, lets review what I call a dynamic live budget:

  • A farmer should maintain a budget that incorporates each of the following financial statements:
  1. Balance sheet,
  2. Income statement,
  3. Statement of cash flows,
  4. Statement of bank operating line / excess cash
  • Each of these statements should be updated at least quarterly, preferably monthly, with the latest actual year-to-date numbers and then projected out for the rest of the year. 
  • The farmer should try to break down the income and expense by related crop year.  For example, the farmer should group the expenses related to growing the 2010 corn crop with the actual and projected income related to the 2010 corn crop. 
  • To ease the presentation in a report, I would set up the budget to report this information on a quarterly basis.  You may want to detail the budget by the month, but I would report it in a quarterly format.
  • The farmer should then incorporate at least one more year if not two more years into the budget. 
  •  By doing a balance sheet and statement of cash flows, the farmer will be able to determine what equipment needs to be bought, what is the appropriate time to buy, when should additional labor be added, etc.

A dynamic live budget is one of the most powerful financial tools that you can use as a farmer to run your operation.  To properly set up the budget will require work on your part and possibly a consultant if you are not comfortable setting up spreadsheets.  However, doing this initial work will tell you a lot about your farming operation and once you get it operating properly, when the banker asks you for the budget at year-end, you simply print out your latest report and hand it to them.

I am fairly certain that all farmers in the upper 10% of returns are incorporating some type of dynamic live budget.  I would love to hear from our readers on what type of budget they are using in their farm operation right now and whether they consider it to be dynamic or not.

Watch Out for the State Disconnect on Tax Depreciation!

Oct 11, 2010

As we have previously noted in a couple of posts, the Section 179 deduction has been substantially increased for this year and next year to $500,000 and the 50% bonus depreciation has been re-enacted for 2010.  However, most if not almost all states do not follow this rule.  I know that Oregon does not follow the federal rule and limits the Section 179 to what the old federal law amounts were with out the stimulus changes and does not follow the bonus depreciation.

For some states, this difference can be substantial.  For example, if your state limits the Section 179 deduction to $25,000 and you purchase qualified property in 2010 and take the full $500,000 deduction on your federal return, your state will require you to add back the $475,000 excess, however, this excess will be allowed to be depreciated under the normal rules.

This means for 2010, that your state income tax may be at least $40,000 or more higher than what you were counting on.  Make sure that you take this into account when doing your year-end tax estimates.

What's Your Contribution Margin?

Oct 08, 2010

The University of Purdue and other universities do a good job of providing estimated crop costs and return guides for each major crop grown in their area.  I decided to take their 2010 Crop Cost and Return Guide and update with three ranges of prices for the five different crop rotations shown.  I am using a low, average and high price for these crops based solely on an educated guess by me as to what prices might be over the next twelve months.  Based on 2008, almost all of these numbers were hit, so I think we stand a good chance of hitting most of these numbers on at least the average and hopefully the high side.

The table is as follows: 

 

              DC Beans
    Cont Rot Rot   DC  With
    Corn Corn Beans Wheat Beans Wheat
               
  Yield 180 191 59 84 35  
               
Low Price               4.50               4.50               9.00               6.00               9.00  
Average Price               6.00               6.00             12.00               7.00             12.00  
High Price               7.50               7.50             15.00               8.00             15.00  
               
Low Revenues             810              860             531             504             315             819
Average Revenues          1,080           1,146             708              588              420           1,008
High Revenues           1,350           1,433              885              672              525           1,197
               
  Variable costs              380              367              206              172              170              342
               
Low Contrib. Margin              430              493              325              332              145              477
Average Contrib. Margin              700              779              502              416              250              666
High Contrib. Margin              970           1,066              679              500              355              855

 

As you can see, in most cases, corn will generate the highest amount of contribution margin to the farm operation, however, this is based upon input costs using 2010 numbers.  I believe that costs for 2011 for fertilizer and fuel will most likely be higher than 2010, therefore, you will need to update with the pricing levels that you expect for these input costs.  Also, double cropping wheat with beans is very competitive with corn and since most of the winter wheat has already been planted in a lot areas, these acres will not be available for corn.

This is a fairly easy spreadsheet to work up.  You just need to determine your total variable farm costs by crop and then plug in your yield and estimated pricing.  Every farmer should prepare and update these spreadsheets before making any planting decisions.

Remember Your 3 to 1 Ratio!

Oct 08, 2010

Now that the USDA has really surprised us with an US corn crop of about 156 bushels per acre, as farmers you need to remember how this will correlate to your planting intentions for this year and next.  Since we can assume at current prices, corn, bean and wheat will be profitable next year, the key ratio is how much bottom line profit is created by each penny move in each of these crops.

If you are a farmer that can grow corn that will yield 180 bushels, and bean or wheat will yield 50 bushels, for every 1 cent move in the crop price, you gain $1.8 in corn and 50 cents in wheat and beans.  Therefore, this ratio is about 3.6 to one.  Beans and wheat will have to increase in price by at least 3.5 times higher for their crop to be worth more than corn.  If you can double-crop beans with wheat, then this ratio will probably drop some and you would have to run the numbers for your farm.

These USDA numbers most likely means the market will need to bid up corn price substantially to get acres away from wheat and beans, however, in this bidding up, bean and wheat will also have to be bidded up to keep the needed acres for those crops.

Make sure you have your budget spreadsheets geared up for the changes in these prices to adequately prepare you for next year's plantings (or winter wheat for this year).  All in all, next year should be profitable, just make sure you pick the crop with the most potential profit.

Ag Struggles in 2nd Qtr, How Will the 3rd Qtr Look?

Oct 08, 2010

In August of this year, The Minneapolis Federal Reserve reported that the agricultural credit conditions in the second quarter were somewhat pessimistic compared to the previous quarters.  The Ninth district comprises the states of Montana, North and South Dakota, Minnesota and parts of Wisconsin and Michigan.

Although the credit conditions for this district were slightly negative, the positive trends for farmers is that they are reducing their capital investment and household spending.  During the period, only 11 percent reported higher household spending and 14 percent reported spending more on capital goods.

Demand for loans and repayment levels were fairly constant.

Cash rents continue to be strong.  Average cash rents for irrigated and non-irrigated farmland were up from a year ago by about 6 and 10 percent, respectively.  However, cash rents for range land was down about 3%.  Values for farmland were up by about 6-8% for the year earlier periods.  "Bankers are starting to get concerned over how much longer these rents and prices can stay this high", a Minnesota lender reported.

According to the report, the survey does not paint a rosy picture for the third quarter.  However, with the dramatic increases in prices during that quarter, I am betting that the actual third quarter report will be much rosier than the expectations.

Use of Bale Wagon Leads to $9.000 Penalty

Oct 07, 2010

In my home state of Washington, we now have a case of the IRS fining a farmer $9,000 for using dyed off-road diesel in his bale wagon to transport the hay from his field to his haystack.  During this transport, the farmer was briefly on a public road and an IRS agent staked him out and then pulled him over to issue a penalty for the use of the off-road diesel on the public road.

The IRS does allow the use of this diesel in tractors, etc. that go from field to field using public roads.  Their interpretation in this case is that the bale wagon is not a qualified farm vehicle, however, New Holland, the manufacturer, and the state of Washington both classify it as a farm use vehicle.  Plus, I think most reasonable people would understand that you are not going to take the bale wagon into town to shop.

The Washington Farm Bureau has generated a letter to the IRS on behalf of the farmer.

I would be interested to hear from any of our readers if they have come across any other action by the IRS similar to this.  I know in today's environment of falling tax revenues that one very easy way for the IRS to raise money is to assess penalties.  Even if they are wrong, many taxpayers or farmers will pay the penalty rather than fight it.  I am very grateful to see the Washington Farm Bureau help out in this situation, since if unchecked, this could lead to substantial fines for almost all farmers.

A Battle For Acres

Oct 06, 2010

It will be interesting to see which crop wins the battle for acres in 2011.  Right now, wheat, corn, beans and cotton are all enjoying much higher prices than last year.  The University of Purdue has calculated that the following returns above variable costs on high quality land are as follows:

  • Corn - $447,
  • Beans - $395,
  • Winter wheat alone- $336,
  • Double-cropped winter wheat / soybeans - $516

On low quality land, wheat alone edged out both corn and soybeans.

With fertilizer prices edging up, corn acres may go down since the return for other crops may be just as good or better with out the extra input costs.

Winter wheat acres have declined each of the past two years down to 37.3 million acres in 2009/10.  For the upcoming year, many estimates peg the wheat crop closer to 41 million acres.

A big incentive is to plant winter wheat and then double crop it with soybeans.   As the projected returns show above, that can get you the best return.  In 2008, about 9 percent of the bean crop was double-crop or about 6.8 million acres.  This year, this acreage had dropped to 2.4 million.  If wheat acres do go up by 4 million acres, then a lot of this will probably be double-crop beans.

Planting choices usually come down to which crop will yield that best return per acre.  Through mid-September, incentives to plant wheat were much larger than the last half of the month when most of the winter wheat crop is being planted.

With cotton prices near or over $1 per pound, many bean acres might go into this crop.

My best guess right now is that almost all crops will have higher acres due to higher prices.  Marginal land will be put into production that was not in production this year.

It will be interesting to see the final numbers.

Consider Taking Dividends Now

Oct 05, 2010

Many farmers created corporations several years ago that have always been taxed as a regular C corporation or may have switched to an S corporation after several years of profitable operations.  These corporations may have several hundred thousand dollars of retained earnings that under current law if they were distributed to the owners would be taxed at a top federal rate of 15% and if the farmer was in the 15% tax bracket on its other taxable income, it would be taxed at zero.

With the current turmoil in the election, it is hard to know if these favorable rates will hold next year.  Therefore, you should carefully review your tax situation with your advisor and determine if you should distribute these retained earnings to take advantage of the low rates.  One negative is that most states will tax these dividends at regular rates, so the actual combined tax rate on dividends for this year can exceed 25%.

Some farmers are concerned that if the money is distributed to them, the corporation will not have enough liquid assets to operate.  There are many ways to reduce or eliminate this problem.  The shareholder can loan the money back to the corporation at very favorable rates.  This allows the farmer to earn better than what they can get on a money market fund or CD (these rates right now are usually less than 1%).  Also, the corporation will generally pay a better rate than they can get at a bank.  The farmer can also contribute the money back to the corporation as additional paid in capital which has no tax consequences.

If the Bush Tax Cuts do expire on January 1, 2011, then your maximum tax rate on dividends will go from 15% of almost 40%, therefore, this year presents a great opportunity to lock in the lower rates with out any risk.

With year-end coming up, I will most likely continue to write posts regarding this situations and other related to it.

Get Ready for Billions of Form 1099s

Oct 03, 2010

One of the little items that was included in the Health Act passed earlier this year was the provision that mandates the filing of form 1099 for a lot more items than is done now.

Under current law, a farmer is normally required to issue a form 1099 for payment of:

  • Services or rents paid to an incorporated entity (individual, partnership or trust), and
  • The services in total for the whole year exceed $600

This means a farmer would usually issue a form 1099 for cash rents, the attorney and accountant's bill, custom harvesting or farming services, etc.  I would estimate that most farmers would have 10 form 1099s or less to file in a normal year.

With the new bill, a farmer will have to issue a 1099 for any "products" or services paid to any entity during the year that totals more than $600.  This includes buying fertilizer from the local co-op, etc.  This means all payments to any corporation will be included.

Under this new law, I would estimate that most farmers will need to prepare in excess of 50-100 of these forms each year.

You are required to obtain the name, address and identification number of each vendor you deal with and record this information on the form 1099.  Most accounting software programs already do a good job of keeping track of this information, however, you have to obtain it first.

In addition, if you exceed more than 100 1099, you will most likely have to file these electronically (the IRS may require all filings be done this way soon).

Many organizations are attempting to get this rule repealed.  I know that I spend at least 20 hours or more each year dealing with erroneous 1099 matching letters from the IRS.  If this new law goes into effect, I would guess this may go up by a factor of 5 or 10.

If you are tired of the extra red tape that Congress is requiring of us, please let your representative know.  I think if the Republicans take back the house, there is a good chance of this getting repealed, but we also thought we would have a new Estate tax law right now and that has not happened.

The new law applies to payments made after December 31, 2011 or essentially the 2012 calendar year.

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