Jul 31, 2014
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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.

FSA Issues Another Update on Base Acres Reallocation

Jul 30, 2014

The FSA issued a release Notice ARCPLC-7 (issued on Wednesday July 30, 2014) on additional information regarding reallocation of base acres. As previously discussed many times in this blog, each "farm" will have an option to update their base acres to reflect the average acres in production during the 2009 to 2012 crop years. This notice provides a couple of examples of how base acre reallocation may happen.

The notice also has a sample letter of the data that will be mailed out (the estimated mailing time appears to be about the first week in August). The producer then has 60 calendar days from the date of the letter to notify the local FSA office of any changes that needs to be made to the data. This is the initial process in updating the farm's base acres.

There is a provision that if the farm has approved double crop acres, both crops will be allowed in the base acre reallocation. If the farm produced double crops in a crop year that was not "approved", the farm appears to be allowed to pick and choose which of those crops it would like to use for that crop year. For example, assume a farm planted 100 acres of corn and then due to weather conditions, etc. replaced the planting with 100 soybean acres. This was not a qualified double crop, therefore, the farm will choose between corn or beans for that year.

There is good data in the notice on how the base acres will be reallocated and it is worth taking a quick look at the notice.

Another Cattle Tax Shelter Bites the Dust

Jul 30, 2014

I have previously done some posts on certain cattle or horse hobby loss cases. The Tax Court released the Gardner case on Monday July 28, 2014. In this case, Mr. Gardner operated a very successful insurance business in North Carolina. In 2001, he met John and David Pearl, who operated several businesses related to cattle and seems to have talked Mr. Gardner into starting a cattle operation to raise genetically superior livestock.

Over the next few years, Mr. Gardner issues numerous promissory notes to Mr. Pearl and various entities. In the tax court memorandum, the listing the various promissory notes ran more than 20 pages (out of a total of 70 pages). Essentially, Mr. Gardner would issue a promissory note to these entities for the purchase of cattle and/or operating expenses and equipment. The promissory notes totaled more than a $1 million, however, it appears that Mr. Gardner effectively paid less than $100,000 on any of these promissory notes. Also, in almost all cases, Mr. Gardner defaulted on all notes and no collection efforts were made to collect.

Mr. Gardner took a net deduction of about $700,000 during 2002-2004. As you can expect, the IRS audited these returns and assessed taxes and penalties. The tax court summarized all of the facts of the cattle operation and then examined whether the cattle operation met the 9 steps normally required under Section 183 (dealing with hobby losses). In our previous posts, we reviewed some of the cases where taxpayers were allowed to deduct the losses since the tax court agreed they were a business and not a hobby.

In this case, I am not even going to list all of these reasons since the taxpayer was essentially found to not have any of the 9 steps be in his favor. For example, the primary goal of Mr. Gardner was to raise genetically superior livestock. This requires meticulous records to be maintained on the cattle being raised. In this case, no records were maintained at all, therefore only commercial cattle values could be used. This value was about $193,000.

The tax court did not view favorably that the cattle loss suddenly rose from about $30,000 or so in 2002 and 2003 to over $600,000 in 2004 when his insurance business netted more than $500,000.

All-in-all, this was not a good case for the taxpayer. In many cases, a taxpayer may owe the tax, but get relief from the penalties which can be at least 20% of the tax owed. In this case, the tax court found the taxpayer liable for the penalty. All-in-all, this was not a good case for the taxpayer.

The Bakken From an Economist's Perspective

Jul 30, 2014

The first item on the Farm Financial Standards Council annual meeting agenda was a discussion on the Bakken Oil Field by Scott Rickard, an economist with Montana State University - Billings. Here are some of the key points from the presentation:

  • Geography - The Bakken oil field essentially covers the Western Half of North Dakota and goes north into Canada.
  • Horizontal Drilling and Fracking - The primary reason for dramatic increase in oil production in the Bakken is the use of horizontal drilling and fracking. The drill will go down vertically for a mile or more and then turn horizontal for two miles or more. They then pump sand and other chemicals into the pipe and "frack" the surrounding material. They continue to experiment with the chemicals, etc. to determine the best method. To frack one well takes 100s of tanker loads of chemicals and water. These trucks can cause major damage to rural roads.
  • The growth in oil production has only been in the "tight" oil segment. The normal methods of oil production have actually decreased, whereas, the methods to get "tight" oil out of the ground have led to the increased oil production in the US.
  • It costs about $8 million to drill a horizontal/fracking well.
  • Bakken oil depletion rates are about 75-80% in the first two years of production. High production in first two years, then much lower production from years 3 forward.
  • The Energy EROI ratios have decreased since the 1930s. During the 1930s, you got a 100 return for each unit energy put into the project. The Bakken energy is now about 5 to 1 and Oil Sands in Canada are about 2.4 to 1.
  • North Dakota's population in 2003 was about 640,000. As of 2013, the population has increased about 84,000 people to 724,000. Most of this growth has incurred in the Bakken region to meet the demand for oil production. How will the demand for services affect the state's resources, especially if and when the oil production demand decreases.
  • Getting new pipelines built takes a long time. This means that rail shipments of oil out of the Bakken will continue to push out grain shipments. This will continue to increase the negative basis for grain out of the Dakotas.
  • The Bakken discount used to be as high as $28 to West Texas Intermediate (WTI). The discount has now dropped to less than $3 and in some cases, there is a premium to WTI in certain months. Much of this is due to the ability of railroads to get the oil to the ports that would normally import oil for other counties.
  • By 2020 or sooner, the Bakken oil field will most likely hit peak production and then start to decline rapidly.

How to Handle Gift of Grain

Jul 30, 2014

We got this question from one of our readers:

"My grandfather gave me a generous gift of soybeans for my college fund. Since he gave me the actual crop, he paid no taxes on it. When I sold it I received a check of around $8,000. I will have file a tax return for the first time. How do I calculate what taxes I owe on the $8,000?"

As with many tax questions we get, the answer to this question is it "depends" on whether she is claimed as a dependent on her parents tax return. We will give the answer for both situations.

If she is not a dependent, then she will report the sale of soybeans as a short-term capital gain (assuming she sold it within a year of harvesting the beans). Her sales price is $8,000 and the cost basis is zero, therefore her total gain is $8,000. If she has no other taxable income for the year, her standard deduction and personal exemption will completely offset this gain. Therefore, she would owe no tax. However, in certain states, the $8,000 gain would be subject to some state income taxes since their exemptions and standard deductions are lower than federal amounts.

Now, if she is claimed as a dependent, then the short-term capital gain will essentially be subject to her parents tax rate. For example, if her parents on are in 25% tax bracket, she would owe about $1,750 in income tax on the gain (the first $1,000 is normally exempt from tax). Again if she is in a state with an income tax, she would owe the same amount of state income taxes.

If she held the grain for more than a year from harvest, this gain would become long-term and if the parents are in the 15% tax bracket, then the gain would be taxed at zero.

The gifts of grain are a valuable method of reducing income tax for the farmer. The gift eliminates this amount of income from both income tax and self-employment taxes and in the case of a child or grandchild who is not a dependent of the grantor and is in a very low tax bracket, in many cases we can completely eliminate the income tax on the gifted grain.

One final recommendation is that the grain be gifted of a prior year harvested crop. If the gift is of grain from current year crop, then the farmer has to reduce their expenses by the cost of the grain. This cost carries over to the recipient, however, it is much better to gift prior year's crop since you no longer have to make that calculation. All expenses are allowed and the basis in the crop gifted is zero.

Base Acre Reallocation Options Under the 2014 Farm Bill

Jul 24, 2014

FarmdocDaily just released today an analysis of the base acre reallocation options under the new farm bill. The report gives a very good analysis of the base acres by the various major crops and the variances between base acres and planted acres for 2012. Here are charts of the major crops by base acres and planted acres of 2012 (taken directly from the report):

CaptureAs you can see, wheat base acres are substantially higher than planted acres. Many of the base acres located in North and South Dakota and other "fringe" areas of the corn belt have now been planted to corn and beans over the last several years. In the percentage terms, the difference for barley is even more dramatic. Barley's planted acres is 3.6 million, whereas base acres are 8.6 million. The difference is 5 million acres or about 58% based on base acres or about 139% based on planted acres.

There is a good table showing how the average acre planting history for 2009-2012 will be used to determine the reallocation of base acres. 

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