Aug 23, 2014
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January 2014 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.

Price Loss Coverage - What is it?

Jan 30, 2014

Yesterday, we posted on Agricultural Risk Coverage (ARC). Today we will go over the rules on Price Loss Coverage (PLC). ARC is based upon both a yield and price component, whereas, PCL is based strictly on price. The USDA will determine the average crop price during each marketing year and compare that to the "base" price for that crop. If the actual average price (or national loan rate if higher) is lower than the base price, then the payment per acre will be owed based on the difference between the actual and base price times the APH for that crop year.

When this was first proposed, most farmers assumed that PCL would not be a good option for corn, bean and wheat growers since the base price for these commodities was so low. Now, almost two years later, the base prices are closer than before, but most likely you will need to run the numbers on your farm. Unlike ARC limiting coverage to a 10% band from 86% to 76%, PLC appears to have no limit per acre, other than the overall $125,000/$250,000 (married) limitation.

The producer will need to make an election this year to elect either ARC or PLC on a crop-by-crop basis. If the farmer elects individual farm ARC that is locked in for all crops on the farm. If no choice is made, it defaults to PLC and all producers must make the same election on a farm or risk losing 2014 crop payments.

The base price for major crops covered is wheat, $5.50/bushel; corn, $3.70/bushel; grain sorghum, $3.95/bushel; barley, $4.95/bushel; oats, $2.40/bushel; long grain rice, $14.00/hundredweight (cwt).; medium grain rice, $14.00/cwt.; soybeans, $8.40/bushel; other oilseeds, $20.15/cwt.; peanuts $535.00/ton; dry peas, $11.00/cwt.; lentils, $19.97/cwt.; small chickpeas, $19.04/cwt.; and large chickpeas, $21.54/cwt.

Each farmer will need to run numerous assumptions based on price and yield to determine if PLC or ARC is the better option for them. USDA will be issuing guidelines on how to sign up for this coverage, but remember if you do nothing, you will default to PLC and you may not get a payment for the 2014 crop year.

We will keep you posted.

How To Make an Extra $100 Per Acre!

Jan 29, 2014

I spent part of today reviewing the new Farm Bill that was signed by the House today and most likely law by next week. I spent most of the time reviewing the Agricultural Risk Coverage (ARC) which is one option that farmers can sign up for. The other option is the Price Loss Coverage which most growers in the Southern states raising peanuts, rice and other related crops will most likely opt for. Most farmers growing corn, beans and wheat will opt for ARC.

The ARC provides payments to farmers if the "Benchmark" revenue is greater than the "actual" revenue received by the farmer for the year. The farmer is allowed to elect either coverage based upon County yields or individual farm yields. However, the County program will make payments using 85% of base acres, while the individual farm will only pay on 65% of base acres. We can see that Congress does not want to add extra work to the local FSA office. The farmer is also allowed to make an one-time election to reorganize their base acres.

Paul explains the farm bill tax implications:

Benchmark calculations use Olympic averages for both yield and price calculations. The previous five years for both yield and average US prices for each commodity is determined. They then throw out the highest and lowest for each and take the average of the remaining three numbers. These averages are multiplied together to arrive at the benchmark revenue for the current year. This number is then multiplied by 86% to arrive at the benchmark revenue guarantee amount. If actual revenue for the current year is less than this guarantee amount, then a claim will be made. The claim will be the lesser of the difference between benchmark guarantee and actual revenue or 10% of the guarantee amount. The Farm Bill is essentially providing protection for crop losses between 76% and 86% of benchmark revenues.

To determine actual revenue for the year, the grower takes their actual yield (or the county yield) and multiply it by the final US average price for that crop marketing year. This number is then compared to the benchmark guarantee.

I ran some numbers for Buchanan County, Iowa based upon the county yields for the last five years and arrived at the following conclusion:

  • The Olympic average yield for the last five years for the county is about 169 bpa.
  • The Olympic average corn price over the last five years is $5.15 (this is for the whole US, not just the county).
  • A claim would be paid if the actual revenue was less than $748.
  • The maximum claim is about $75 and if the yield was 160 bpa and the average corn price was less than $4.25, then the full claim of $75 would be paid. The average price would have to rise to almost $4.75 to have no claim.
  • If the yield was 170 bpa, then a full claim would happen at about $4.10. At about $4.40, no claim would be owed.
  • If the yield rises to 180 bpa, then a full claim is allowed if the average price falls below $3.70 and no claim is allowed if the price goes over $4.15.

Let's assume we have a Buchanan farmer with 1,000 corn base acres in 2014 and the county yield ends up at 170 bushels per acre and the final corn price for the year is $4. In this case, he would receive the maximum $75 per acre on 850 acres (1,000 times 85%) or $63,750. Since the payment limit is now $125,000 per person ($250,000 for married couples), the farmer will get the full amount. In fact, the farmer, if married he could farm 4,000 acres and collect full ARC payments. Under the old law, this most likely would be limited. If these numbers were based on his actual yields, then the payment would be reduced to 650 acres times $75 or $48,750. Using this coverage, the farmer could farm 6,000 acres and collect full ARC payments.

ARC is not crop insurance but rather a replacement for ACRE/DCP, etc. For counties with high average bpa, I expect that in a year of low prices, the amount of ARC allowed per acre could easily approach $100. I also ran the numbers for soybeans and it appears that it will be much tougher for farmers to collect much for the current year. To get a full claim of about $47, the yield would most likely have to drop by about 10% and the average price per bushel would be in the $9 range.

I did not run numbers for wheat, but my educated guess is that based on current price trends, there is a excellent chance that full claims will be made for wheat growers for the 2014 crop year. I could easily see a $50 or more payment per acre for wheat farmers with higher yields.

For farmers facing lower revenues for their 2014 crop, the new Farm bill may actually provide more revenue than the old farm bill and it will be based upon the price and yield risk borne by the farmer, rather than the simply collecting a check for being a farmer. We will be doing additional posts on the farm bill over the next few weeks, but I wanted to provide guidance to our farmers now. There is over 900 pages to the new farm bill and the ARC section only covers about 20 or so pages.

We will keep you posted.

Not Too Late to Make Portability Election!

Jan 28, 2014

The IRS just released Revenue Procedure 2014-018 that now allows an executor of an estate to make a late portability election.

Portability allows the unused estate exemption of the first spouse to pass away to be "ported" over to the surviving spouse. For example, if Farmer Bean passes away in 2013 with a total estate value of $2,250,000, there is a $3 million estate exemption that has not been used ($5.25 million less $2.25 million). If the executor of the estate does not make a timely filed Form 706 electing portability, the law currently states that the estate will not be allowed to port over this $3 million exemption to the surviving spouse increasing her total exemption to $8.25 million.

This law is only a couple of years old and the there has been mass confusion by the public and practitioners on how this election was to be timely filed including the fact that the IRS had not issued a new Form 706 for several months after the law was in effect.

Therefore, the IRS has come out with Revenue Procedure 2014-018 to allow for almost any estate to now easily file Form 706 and elect portability. In order to qualify for the automatic extension, the following requirements must be met:

  1. The taxpayer is the executor of the estate of a decedent who: (a) has a surviving spouse; (b) died after Dec. 31, 2010, and on or before Dec. 31, 2013; and (c) was a citizen or resident of the United States on the date of death.
  2. The taxpayer is not required to file an estate tax return (their estate was less than the lifetime exemption amount);
  3. The taxpayer did not file an estate tax return during the time period required for filing an estate tax return to elect portability;
  4. A person permitted to make the election on behalf of a decedent, must file a complete and properly prepared Form 706 on or before Dec. 31, 2014; and
  5. The person filing the Form 706 on behalf of the decedent's estate must state at the top of the Form 706 that the return is “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER Code Sec. 2010(c)(5)(A).”

Many farmers and their families are not aware of this special provision. If anyone you know has a family member that as passed away during 2011-2013 and their estate was less than $5 million, this provision may apply to them and it is important for them to discuss this with the appropriate estate tax advisor. It may save them a $1 million or more in additional estate taxes.

You Must Start IRAs Draws at Age 70 1/2

Jan 26, 2014

We had a reader ask the following questions:

"As I understand the requirement for the IRA withdrawal at age 701/2. If the person is still working at 70 1/2 then it is not necessary to draw from your IRA. Is this true? Another question can a farmer for 2013 expense the full cost of a machine shed as long as you are not exceeding the $500k limit."

These are two separate questions, but I will answer both. When a farmer has an IRA and reaches age 70 1/2, they are required to start taking their required minimum distribution (RMD). Now, there are two options regarding when you first reach this age. You can either take your first distribution in the year you reach this age or delay it for one year and then take it the following year. However, when you delay it for one year, in the second year you will be required to take two distributions, the one from the previous year plus the current year required RMD.

Normally, we suggest that farmers take it in the first year so they do not bunch up their income in the second year. In some cases, if you are still working and covered by a retirement plan (and do not own more than 5% of the company), you may not need to take a RMD out of that retirement plan until you retire, but you will always be required to take it out of your IRA beginning at age 70 1/2. The penalty for not taking it can be steep. It is 50% of the RMD for that year.

For the second question, a farmer may build a machine shed in 2013 and deduct 50% of it using bonus depreciation. However, a machine shed is not eligible for the Section 179 deduction which is limited to $500,000. Therefore, the reader will be able to take an immediate deduction of 50% of the machine shed cost and depreciate the remainder over 20 years. He will still have his full $500,000 Section 179 limit to use on other farm equipment.

If Corn Drops a $1, How Much Does Farmland Prices Drop?

Jan 25, 2014

AgriBank, which is owned by 17 affiliated Farm Credit Associations primarily located in corn belt states issued a 14 page analysis of farmland values and the effect on these values if commodity prices decrease or interest rates rise. Their analysis included regression studies and here are some of the conclusions:

  1. If net farm income or net cash rent income decreases by 50%, then cropland values would go down by about 33 percent. This would not be based upon a one-year trend, but would probably take at least two continuous years to lead to these value reductions.
  2. For every dollar decrease in corn prices, then crop land values would decrease by $298 per acre.
  3. For every 1% increase in long-term interest rates, then crop land values would decrease by $357 per acre.
  4. If there is a long-run average of cash rents based upon $4.50 corn and 4% long-term rates, then they suggest there would be a 34% correction in crop land prices.
  5. Putting it all together, they estimate if corn remains at current levels and interest rates do not change, then there should be about a 10-12% correction.
  6. They estimate it would take two-three years for long-term rates to get back to the 4% plus range.

Falling crop prices and rising interest rates could take several years to be fully reflected in crop land values. They are also suggesting that a reduction corp prices would not affect farmers like the 1980s. They are already noticing a leveling off or reduction of top prices across their 15 state region and it will be interesting to see how crop land prices compare at the end of 2014 versus 2013.

We will keep you posted.

Interest Under USDA Prompt Payment Act Mean Only One Year!

Jan 23, 2014

We were informed of a farmer that had a several year delay in receiving his 2010-1012 FSA direct payments. Many farmers naturally assume that if the USDA is late in making payments to a farmer, interest will be paid from the original due date until the final payment date. This is true, however, only if that time period is less than one year. If the period exceeds one year, the Prompt Payment Act as it applies to the USDA direct payment program and it appears most if not all of the other programs has a one year limit on the payment of interest.

Therefore, if you are waiting to be paid by the USDA for direct or other payments and the delay is more than six months, it pays to put a burr under their saddle and get it resolved. If it goes beyond a year, then you may be out of luck on getting all the interest you may think you are owed.

The current USDA interest rate under this program is 2.125% as of January 1, 2014 to June 30, 2014. It was lowest in the first six months of last year at a whopping 1.375% and peaked at 15.5% in 1982 (even I still remember those high interest rate years, there may be some young farmers that have never paid double-digit interest rates). Here is a link to the rates paid since the start of the Prompt Payment Act.

Here is a link to the USDA Sugar Loan program showing on page 1-10 that the interest shall be limited to one year.

Cash Received Does Not Equal Gain

Jan 23, 2014

We got the following question from a reader:

"I bought 3 farms in recent years. Is there a way to sell one or part of one and pay the other 2 off without paying tax on that money?"

I can give a general answer to this question, but without having the actual facts of each farm's cost and fair market value, it will be difficult to give a full answer to the reader.

In general, when you sell property, you are only taxed on the amount of gain the property generates, not the cash received. I get the following common conversation many times each year.

A client will come in and tell me they sold some real estate and since they only got $20,000 of cash, they "know" that the gain is only $20,000 and tax will be about $3-4,000. However, after discussing the matter with them, we find out they have re-financed the property two times; pulled out $200,000 of equity; and rolled over a Section 1031 gain of $300,000 into the property. After doing the final calculations, I have the sad task of telling the client they now owe $100,000 of capital gains taxes and they only have $20,000 of cash. This sometimes becomes a heated discussion since they can't seem to understand how the gain can be higher than $20,000 of the cash they received. After explaining the facts of their situation, they usually end begrudgingly understanding it, but needless to say, they are not happy about it. Our better clients usually call us before selling real estate to determine what the gain and tax actually are.

Now for the reader's situation. I am assuming that each of his farms have increased in value since this is most likely the only way to sell one and pay off the other two. Now if the property has increased in value enough, he may be able to get cash to both pay off the debt of the other two and PAY the income taxes, but most likely not get by without paying any tax.

For example, assume he bought each farm for $1 million and had debt of $500,000 on each property. If the value of one farm has increased to about $1,750,000, he could sell that farm, pay off the debt of $500,000; pay income taxes of about $175-200,000; and have at least $1 million to pay off the $1 million of total debt on the other property.

Now some farmers think they could use a Section 1031 exchange to sell their farm, rollover the gain into other farmland, etc. However, when you sell farm land using a Section 1031 exchange, you must roll over all of the cash received and not pay off debt of other farm land owed.

The bottom line for our reader is that most likely he can sell the farm land to pay off the debt on the other two farms, but he will owe some taxes too.

Average is Important for 2013 Tax Filing

Jan 21, 2014

We had a reader ask the following question:

"I would like to here more about income averaging over years and when should someone think of it or not?"

Farmers enjoy a unique method of computing their income tax liability versus other taxpayers. Due to the possible wild swings in farm income, the Tax Code allows farmers to elect to spread their current year farm income over a four-year period (the current year plus the last three years). By electing this spread, a farmer may be able to substantially reduce their current income tax liability by dropping high income tax brackets in the current year and moving it to the previous three years with lower tax brackets.

For example, assume a farmer earns $300,000 from farming in the current year and without using income averaging, his tax liability would be about $65,000. Now, the farmer elects to spread $210,000 of his current year farm income over the last three years. During those years, he had exactly zero taxable income. His income tax liability now will be completely taxed in the 15% tax bracket resulting in total taxes of about $42,000 thus creating tax savings of $23,000.

Therefore, the ultimate goal of farm income averaging is to spread current year higher tax bracket farm income into the three previous year's lower tax brackets (if they are available; if previous years tax brackets are all higher than current year, then no tax savings will result).

With the imposition of the new 39.6% high income tax bracket for 2013, high income farmers will alway want to use farm income averaging to get rid of their 2013 farm income that is in both the 35% and 39.6% tax bracket. They will always save money by doing this. Let's look at an example:

A married farmer normally has $750,000 of taxable income each year. The normal tax liability for 2013 is about $245,000. The farmer elects to carryback about $350,000 of farm income to the previous three years that is all taxed at 35%. He saves 4.6% on $300,000 or $13,800. In 2014, he has the same amount of income and saves another $13,800 less $1,150 taxed at 4.6% on the 2013 year. In 2015, he has the same amount of income. He saves $13,800 in 2015 less about $6,000 that is taxed at 39.6% in 2013 and 2014. In 2016, he makes the same election, however, now his savings are only about $3,500 since his only savings is that part of the income that will be taxed at 35% in the 2015 tax year. The rest of the income will all be taxed at the highest rate.

Therefore, by electing farm income averaging in all four years, the farmer ends up saving about $37,000 over the four-year period. This means that all farmers in the highest tax bracket for 2013 must use farm income averaging to maximize your income tax savings. After you get your return back from your tax advisor, make sure to check that Schedule J has been prepared and that enough farm income was elected to be carried back.

Section 179 Update (or Not)

Jan 20, 2014

We had a reader ask the following:

"I haven't been able to see if there is any development in increasing the limit for Sec 179 lately for 2014. I am holding out on any equipment purchases until I see an increase in the limit. I would appreciate it if you keep us informed on any changes or lack of changes."

I know that many farmers have the same questions as this reader. Here are my official updated odds on when we might know what the actual 2014 Section 179 amounts will be:

By Memorial Day 10 Billion to 1

By Labor Day 10 Million to 1

By the November Mid-Term elections 500 to 1

Between the November Mid-Term Elections and December 15, 2014 25 to 1

After December 15, 2014 and before January 1, 2015 1 to 1

After December 31, 2014 5 to 1

Now, these are not actual odds, but this does lay out our timing on the actual 2014 Section 179 amount . We must remember that the 2012 amount was in the $130,000 range for almost all of 2012. It was not until after the elections when they updated it to $500,000. That bill was passed by the House and Senate on about the last day of the year and signed by President Obama after year-end.

Since there is a mid-term election this year and any change to Section 179 will most likely be in conjunction with other major tax law changes that almost always happen after the elections, we are fairly confident that farmers will only have a few days of knowing the actual amount before year-end. This does not leave much time for actual planning.

For planning purposes, the current law is $25,000 and we think it should exceed $100,000, but who knows if it will, when it will, and the actual amount. If you need to purchase farm equipment, I would go ahead and make the purchase. If the Section 179 incentive is needed to finalize the purchase and you do not need the equipment now, I would hold off.

Our Crystal Ball is very cloudy, but I am almost completely certain that the actual Section 179 expense deduction limits will not be known for several months (and remember, they may keep it at $25,000). As usual, we will keep you posted.

It Maybe Too Good to be True

Jan 19, 2014

The Wall Street Journal ran an article on Saturday regarding the Larry E. Austin et al tax court case that was decided in December, 2013 (you will need a subscription to the online version to read the article). This tax court case involved two families who owned a very successful distressed debt investment company. In 1999, they elected to contribute their ownership of the business to a new S corporation with the ownership 47.5% by each individual with the remaining 5% owned by an Employee Stock Ownership Plan (ESOP).

Employers can make tax-deductible contributions to an ESOP and any earnings allocated to the ESOP grow tax-free until the funds are distributed to the participants when the reach age 59 1/2 or later.

When the two shareholders converted their interests into the new S corporation, they also executed new employment agreements. These agreements were structured to provide, for tax purposes, that the stockholders would not own their shares for several years. Unlike other pension arrangements, tax laws do not subject ESOPs to income taxation on their share of earnings from an S corporation. Therefore, during the period that the two stockholders did not "technically" own the shares in the S corporation, 100% of the income was allocated to the ESOP, therefore, on an annual basis, no income tax was due on the income of the S corporation.

As you can guess, the IRS did not appreciate this and took it to tax court. The court ruled last month in the taxpayer's favor on the technical issue surrounding the restrictions of the employment agreement. The IRS has appealed the case and it will be interesting to see the final resolution. If this is upheld in favor of the taxpayer AND Congress does not change the law, this may be a very favorable method of sheltering farm income until retirement. We shall see and will keep you posted.

Note - The US Tax Court Web Site is down for maintenance for a few days so I was unable to post a link to the court case.

Grain Gifts - How Are They Taxed?

Jan 16, 2014

We had an advisor send us the following question today:

"We have a farm client who is a cash basis tax payer. He is considering making a gift of grain to charity in 2014. In your opinion, would it be necessary for him to make that gift out of grain harvested in 2013 or could he use grain harvested in 2014, and still be allowed to deduct the cost of production on those bushels given in addition to taking the charitable tax deduction?"

When you make a gift of raised grain to an individual such as a child or grandchild, it is important that the gift is of grain harvested in the previous tax year. Otherwise, if the grain was harvested this year, you are required to reduce your current year expenses by the cost of raising that grain. This can be a pain to calculate and reduces the self-employment tax savings that come with a prior year tax gift.

Now, with the contribution of grain to a charity, we no longer care whether the crop was harvested this year or in previous years. The tax law allows you to completely deduct the costs associated with the grain on your schedule F. Most likely, the main reason for this is that any cost allocated to the grain would be allowed as a charitable deduction, therefore, the law does not require this calculation.

However, the last part of this question results in a double deduction which would not be allowed. Since there is no cost allocated to the grain that is gifted, there is no charitable deduction to report. Rather, since you are reducing your schedule F income by the amount of grain given, this essentially results in your charitable deduction. You are not allowed to deduct both on schedule F and on schedule A.

There is a double bonus to making these types of gifts if you are subject to the new net investment income tax. By making a charitable gift of grain, you reduce your adjusted gross income resulting in a 3.8% reduction in your tax liability and also reducing your self-employment tax by at least 2.9%.

Co-Ops and Member Equity Risks

Jan 14, 2014

I recently came across an article in a USDA magazine called Rural Cooperatives that discusses the increased risk factors cooperatives have faced including class action lawsuits by members alleging improper management of capital credits. The article can be found here.

The article lists a number of reasons for different lawsuits including failing to retire member equity despite having the financial wherewithal to do so, having no system in place to routinely return member equity, and not notifying its members and patrons of their member equity allocations among others.

The article also discusses some risk management processes, the first and foremost being evaluating the co-op’s member equity policy and adhering to a rational member equity management plan.

I highly recommend the article, especially if you are a board member of a cooperative. It is a good reminder of the importance of a member equity management plan and the importance of promoting goodwill with members and patrons.

ACA Makes Health Insurance Taxable - Or Does It?

Jan 13, 2014

The Affordable Care Act (ACA) contains various provisions that affect farmers, even those with less than 50 employees. One of the primary provisions concerns the payment of health insurance premiums for employees who are not covered by a group plan. In the past, the payment of these premiums was usually deductible for the farmer/employer and a non-taxable fringe benefit to the employee.

With the ACA, it is likely that most farmers who provide health insurance for their employees AND is not provided by a group plan will be allowed to deduct the premium, however, the premium paid will be taxable compensation to the employee. For many farmers, it may make sense for them to have their employees obtain health insurance from the state or federal exchange and reimburse the employees for these premiums (add it to their W2 wages) than to offer a group insurance plan.

Since farm employees generally earn a fairly low wage (compared to their urban counterparts), their actual out-of-pocket cost may be substantially lower than a group insurance premium. Therefore, it may be cheaper for the employer to cover this subsidized premium (again as W2 compensation), then offer a group plan.

For example, assume a farmer wants to cover 100% of an employee's health insurance premium. The employee can obtain this coverage for $50 per month on a subsidized basis, whereas, the cost to provide this as part of a group plan will be $350 per month. If the farmer is in the 25% tax bracket, the net taxable cost of the group premium is $262.50 per month. The after-tax cost of reimbursing the employee the $50 and running it through payroll is about $40 and if the farmer wants to make sure the employee breaks even, it will cost another $10 or so per month. All-in-all, $50 after-tax is still much lower than $262.50.

As with all ACA items regarding health care and insurance, this whole arena is in a state of flux politically. This is the current rule, but change can happen quickly. We will keep you posted.

Properly Safeguard Your Private Information

Jan 09, 2014

Just a quick reminder to always safeguard your private information. Identity thieves love tax season and tax related identity theft cases is a growing problem.

The IRS recently reported identity theft affected 1.2 million taxpayers in the calendar year 2012 and an additional 1.6 million were affected through June 29, 2013, an increase of approximately 33%. In most cases the IRS was able to determine the proper owner of the Social Security Number, however, taxpayers will face delays as it takes the IRS an average of 312 days to resolve tax related identity theft issues, which becomes an even larger issue for the taxpayer if a refund is due!

Some simple ways to protect yourself include avoiding shared or public computers, avoid sending anything with sensitive information via unsecure email and beating the identity thieves to the filing punch by filing as early as possible.

Decant a Trust - Not Wine

Jan 07, 2014

The Wall Street Journal had an interesting story regarding the decanting of a trust when it is appropriate. When a farmer sets up an irrevocable trust and funds it, it is normally extremely difficult to change the structure of the trust, even by the farmer. This usually involves a costly trip to the courts to get terms changed.

Decanting allows a trustee to change certain terms of a trust by "pouring" the assets from an old trust into a new trust. So far, 21 states have adopted decanting laws, with Wyoming being the latest.

The trustee can't change beneficiaries' vested interests in the trust, but for example, the trustee can change the trust to another state with more favorable terms or push back the age when a beneficiary can receives a payout.

Decanting usually costs about $2,500 to $10,000 versus multiple $10,000 for a trip to the court to get a trust changed. Another provision of decanting in certain states is the ability to set up multiple trustees for each function such as handling investments, handling the payouts to beneficiaries and perhaps one for handling the trust paperwork.

With more and more irrevocable trusts being set up by farmers, it may make sense to use the decanting process if your goals for the trust have changed.

Roger's Top Ten

Jan 06, 2014

Roger McEowen from Iowa State University and their Center for Agricultural Law and Taxation (CALT) just listed his Top 10 Ag Law and Taxation Developments for 2014.

Leading off Roger's Top 10 list is his favorite Tax Court case of 2014 (sarcasm intended), the Morehouse case. We have posted on this Case before and Roger and I both agree that the Tax Court is likely off base on their decision. However, this case is under appeal and if the appeal does not work, then this will be the law for those farmers and landlords receiving CRP income. Under this case, all CRP income will be subject to self-employment tax (an exception for those receiving social security).

Roger's next item concerns the introduction of the 3.8% net investment income tax mandated by Obamacare. We have done several posts on this subject and Roger has a good review of the tax and its implications. Roger then covers the following topics:

  • Clean Water Act Developments,
  • Unconstitutional "takings" cases and the effect on property rights,
  • Legal issues surrounding patented seeds,
  • Special Use valuation and some of the pitfalls,
  • "Climate Change" litigation,
  • No free pass for "biogenic" carbon dioxide gas emissions,
  • The importance of hiring an "Ag" lawyer in certain situations,
  • Iowa Legislature wipes out Iowa State Supreme Court decision on state recreational use statute.

I think you will enjoy reading his analysis. On another note, I will be helping Roger with a two day Ag Tax CPE in West Baden Springs, Indiana in early June of this year. Later in the month, we will be in West Yellowstone, Wyoming doing another two day session. These CPE sessions are designed for CPA's, attorney's or anybody interested in getting updated on farm and estate taxation and they are a lot of fun and even better informative. If you are interested in attending, simply click on the link shown for the site you want and sign up.

Remember Your Simplified Home Office Deduction

Jan 03, 2014

Beginning this year, a taxpayer is allowed to use a simplified home office deduction. In years past, a taxpayer was required to calculate this deduction based upon the office square footage divided by the home's total square footage. This percentage was then multiplied against the following items:

  • Interest
  • Real estate taxes
  • Insurance
  • Repairs
  • Other home costs
  • Or Rent

The sum of these numbers plus a representative share of the depreciation on the home office was the calculated home office deduction.

However, for 2013, the IRS now allows a simplified home office deduction and they just released publication 587 which gives you the details on how to calculate the deduction. In brief, the deduction is simply $5 times your total office space used in the home. If you choose to use the simplified method, you are not locked into using it in the future. You can switch from one to the other each year. If you have carry over home office deductions, these are not deductible until you use the regular method. The limit on the simplified method is 300 square feet times $5 or $1,500.

For many farmers who have a home office in their personal residence, this may be a much simpler method and in some cases, it will yield a greater deduction.

Related Party Messes Up a 1031 Exchange

Jan 02, 2014

In the North Central Rental & Leasing, LLC v. US decision out of North Dakota just released this week (the cite is AFTR 2d 2013-7045 (I do not have a link to the actual case on a free site yet)), the Court found that the taxpayer's use of related parties to help accomplish a Section 1031 exchange was too much of a good thing and required all gains to be recognized as income. The sad part is if the taxpayer had simply not used the related party, the Section 1031 exchange would have been allowed.

North Central Rental & Leasing, LLC (North Central) was formed by Butler Machinery Company (Butler), a Caterpillar dealer located in North Dakota to operate their equipment rental activities. Before the formation, all of the rentals were done by Butler Machinery. It appears that Caterpillar in conjunction with Price Waterhouse Coopers had recommended a structure whereby the subsidiary would own the rental equipment (which is depreciated while being rented) and whenever a sale of equipment occurred, North Central would transfer the equipment to a Qualified Intermediary (QI), who would then sell the equipment to an unrelated third-party.

Within 180 days of the sale (usually much quicker), Butler would then purchase equipment from Caterpillar and sell it to the QI which would then transfer the equipment to North Central. Since Butler was a related party to North Central, under the related party rules of Section 1031, these transactions did not qualify for 1031 deferral treatment. Since over the time period involved in the audit, there were 398 like-kind exchanges with large six-figure gains on each sale, you can envision how much gain was involved.

However, if North Central had simply had the QI purchase the equipment directly from Caterpillar, most likely, the Section 1031 deferred gain treatment would have been allowed. By simply putting Butler between North Central and Caterpillar, it messed it up. Now you may ask why Butler got involved. Caterpillar offered a six months same as cash terms for Butler to purchase the equipment. Therefore, they could have up to six months free use of the cash from the sale of the equipment by North Central and that appears to be the only primary reason why Butler got involved.

Therefore, the bottom line is that the free use of money for six months (worth about 5% at the most), caused all of the deferred gain to be taxed at most likely 40% plus since most it not all of these gains were not capital gain (depreciation recapture).

Anytime you have a Section 1031 exchange and if any related party is involved in the exchange (whether purchasing or selling), you must discuss it with a qualified tax advisor. There have been way too many cases where the related party invalidates the exchange. Don't let it happen to you!

Cutting Horse Loss Not Always Deductible

Jan 02, 2014

One of the most challenged "businesses" by the IRS is anything that involves a horse. In a US Tax Court case issued on Monday, December, 30, 2013, a rich Texas family found out how much it can cost when the loss is not allowed. In the Travis Mathis and Bettina Jary-Mathis case, the facts are as follows:

  • In 1992 Ms. Bettina Jary married Travis Mathis, the grandson of one of the founders of Brown and Root, a very lucrative engineering and construction company. As one of the owners of the company, the taxpayers enjoyed dividend and investment income of several million per year.
  • Ms. Jary-Mathis had grown up on a ranch in South Texas and had taken part in cutting horse competitions during her years before marriage. A cutting horse competition involves a judging of a rider and their horse based on how well they cut a cow from the herd. I have personally have watched a couple of these competitions and there is a lot of skill involved. If I tried it, I am sure I would end up off the horse and in with the cows.
  • In 1995, the taxpayers decided to get into the cutting horse business. From 1995-2000, they managed it as a training operation. She bred her mares to high-quality stallions to produce horses capable of competing in the premier cutting events. However, as you can probably guess, the winnings did not cover their losses.
  • After sustaining losses for the first five years and losing her on site trainers, they decided to shift the farm's focus to breeding rather than training. To build the reputation of the ranch, they only purchased broodmares with strong bloodlines and kept only those that produced successful foals. By 2007, the farm possessed an exceptional broodmare collection.
  • The taxpayers had a written business plan, maintained very good records and ran the cutting horse operation like a "business".

However, the IRS somehow decided that any business that had shown a cumulative loss of over $8 million from 1996 to 2008 with over $3 million occurring during 2006-2008 is not a business, but a hobby. The IRS assessed an income tax liability of about $1.2 million for 2006-2008 and assessed a 20% accuracy-related penalty of another $240,000. With interest, the taxpayers would owe over $1.5 million.

The Tax Court addressed several components of whether the farm was a business or hobby as follows:

  • Manner in Which the Taxpayer Carries on the Activity - The fact that the taxpayer carries on an activity in a businesslike manner and maintains complete and accurate books and records may indicate a profit motive. On balance, this factor favored the taxpayers.
  • The expertise of the Taxpayer or Their Advisors - The taxpayer's expertise, research, and extensive study of an activity, as well as their consultation with experts, may indicate a profit motive. The Tax Court indicated that a failure at the outset of starting the farm to consult experts indicated they lack a profit motive (not sure if I totally agree with that conclusion, many successful businesses never consulted an expert before they got started).
  • The Time and Effort Expended by the Taxpayers in Carrying on the Activity - Ms. Mathis typically spent at least 40 hours per week on the cutting horse activity and more than 60 hours during top cutting events. However, the Tax Court noted that although she worked hard, there was substantial personal and recreational aspects. On balance, this factor weighed in favor of the taxpayer, but the personal and recreational aspects limit its effect.
  • The Expectation That Assets Used in the Activity May Appreciate in Value - An expectation that assets used in the activity will appreciate in value may indicate a profit motive even if the taxpayers derive no profit from current operations. However, the expectation is that the appreciation will exceed accumulated operating losses. The total value of the cutting horses owned by the taxpayers at the time of audit was only $1.2 million. This is substantially less than the accumulated net operating losses of over $8 million. The Tax Court also indicated that any appreciation in the land and buildings would be related to an investment nature, not the cutting horse operation. Therefore, the Court indicated the evidence did not show the activity was operated for profit under this factor.
  • The Success of the Taxpayers in Other Similar Activities - None of the taxpayer's past activities provided any evidence of a profit motive.
  • Taxpayer's History of Income or Losses - A history of continued losses with respect to an activity may indicate the taxpayers lacked a profit motive. Although a series of losses during the start-up stage can be normal, the taxpayers had never incurred an operating profit over a 13 year period. The taxpayers also showed dramatically lower losses in the years after audit, however, the Tax Court indicated this was not from greater sales, but rather lower expenses. They also specifically stated that the audit, not the desire to earn profits, may have triggered the reductions. Accordingly, the Court gave little weight to the decline in expenses in determining whether they had a profit motive. Therefore, this factor weighed heavily against finding a profit motive.

The Tax Court added up the factors in favor of the taxpayer (about 1.5) and the factors against the taxpayer (at least 4) and most likely placed a large amount of weight on factor 6 and agreed with the IRS that the cutting horse farm was a hobby and not a business. Therefore, the taxpayers ended up owing $1.2 million of taxes plus interest, however, the Court did rule that the 20% accuracy penalty was not owed which saved them about $240,000.

The bottom line - If you have a farm business that shows large losses for many years with substantial non-farm income, you will most likely get audited at some point and in most cases, you will lose the audit.

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