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June 2012 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.

More Updates on the Senate Farm Bill

Jun 29, 2012

Here are additional updates and comments on the Senate Farm Bill:

  • Eliminates Direct Payments, Counter-Cyclical Payments (CCP), Average Crop Revenue Election (ACRE) payments and Supplemental Revenue Assistance Payments (SURE) as of the end of the 2012 crop.  Beginning with the 2013, all of these payments will be eliminated.  This creates $15 billion in savings for deficit reduction over the five years of the Bill.
  • "Ends Farm Payments to Millionaires".  This is the Senate's heading on this part of the Bill, but it actually refers to payments not being allowed if the total AGI for the person or entity is $750,000 or more.
  • Payments will be capped at $50,000 per person or entity.
  • Payments will only go to farmers with an active stake in the farming operation.
  • A new program called Ag Risk Coverage (ARC) will be implemented that will complement current crop insurance programs.  It will protect against both yield and price losses.  Farmers can make a one-time choice between individual farm level coverage of county level coverage.
  • Payments will only be available when actual losses are experienced off of a benchmark revenue calculated using an Olympic average of the previous five crop years (throwing away the high and the low).  Payment rates depend on whether individual or county coverage is elected and will only be paid on acres planted.
  • Marketing loans will still be available.
  • Current Sugar Program is extended through the 2017 crop.
  • A stronger dairy program is proposed to protect dairy margins equal to the difference between the all-milk price and a national feed cost.
  • CRP will be phased down from the current 32 million acres to 25 million acres over the next few years.

 

My comments are as follows:

For many farmers, the chance of collecting much money each year under these programs will be somewhere between slim and none.  They are also tightening up the rules on active participation and the AGI limits are now a hard number with no distinction between farm and non-farm income.

The dairy program may provide additional needed margin relief to diary farmers and there appears to be no cap on these payments.  However, to participate, the farmer will be required to pay an annual assessment fee based upon pounds of production and is capped at $2,500.  This fee is designed to cover the cost of accumulating the data needed to determine the pay-out, if any.

We are sure that the House will have changes and the final Bill will not be exactly like this, but many of these provisions will remain.

Obamacare Survives the Supreme Court

Jun 28, 2012

The Supreme Court just issued their ruling stating that Obamacare is partly constitutional and partly nonconstitutional, but the constitutional right of Congress to levy taxes trumps the Commerce Clause.

This was an extremely tight 5-4 ruling, with Chief Justice Roberts siding with the four more liberal justices.

For now, the most immediate effect facing farmers is the imposition of the Medicare surtax on earned income and unearned income starting Jan. 1, 2013.

Even if Romney gets elected, any repeal of this will happen after Jan. 1, and who knows if it would affect this part of the bill or not.

Take Advantage of State Programs

Jun 28, 2012

Our blog tends to focus on the federal issues regarding income taxes.  Sometimes we forget that state sales, income and other taxes may end up costing the farmer more than federal income taxes.

For example, in Washington state, we do not have an income tax, but we do have sales, property and a business and occupation tax.  When you add up all of these taxes, a farmer may pay more in our state than a state with an income tax.

For example, in our state, farmers pay sales tax on consumables that they use in the farming operation such as supplies.  They would also pay sales tax on all replacement parts unless they file with the state to be exempt.  This replacement part exemption applies to parts used to make necessary repairs to farm equipment.  It does not apply to betterment's that are put on farm equipment such as installing a new GPS system, etc.

If a farmer did not know about this exemption and needed to purchase a major repair part for their tractor or combine, the farmer could easily spend $1-10,000 in unnecessary sales tax.

Are you taking advantage of all of the state tax exemptions available to you in your state.  For farmers in multiple states, it is even more important to know the rules for each.

One AGI Instead of Three

Jun 27, 2012

For farmers who are enrolled in ag programs with the FSA, there are currently three different levels of AGI (adjusted gross income) that affect whether they qualify to receive any payments from the FSA during the year.  These levels are:

  • $500,000 of non-farm income
  • $750,000 of farm income
  • $1,000,000 of non-farm income, but OK if 66.66% is from farm income
     

These levels were implemented with the 2008 farm bill and we are just now starting to see payments being disallowed. In some cases, the disallowance is due to income earned before the farm bill was even implemented, which prevents us from doing any planning.

The Senate farm bill passed last week contains a provision that will only disallow payments due to AGI being more than $750,000 from all sources on a rolling three-year average. This provision will apply to 2013-2017 crops. For many of our farmers, this will be fairly easy to stay under, but there may be many farmers with substantial off-farm income that will trip them up if they don't do planning.

Also, remember, with the new farm bill there are no more direct payments and a farmer will normally only receive a payment if certain crop insurance triggers are met. If farm prices stay fairly high and no weather issues arise, the chance of a farmer collecting any funds during these years may be slim or none.

We will continue to update our readers on pertinent provisions of this farm bill over the next few weeks and perhaps the House will get its act together and get a final bill before Labor Day.

 

With Low Interest Rates, Special Use Valuation May Not Save Much Estate Tax!

Jun 15, 2012

With the explosive increase in cash rents and the continued decrease of interest rates, the savings by electing special use valuation for estate tax purposes may not be available in 2012.

One of the special estate tax provisions for farmers is the option to elect to reduce the value of the estate to reflect the value based upon capitalization of rental income of their farmland.  If this resulting number is substantially lower than the normal fair market value of the farmland, the estate can elect to reduce the value to this number.  The rules and regulations on this Statute are complex and the penalties for failing to properly make this election can be extreme, but the purposes of this post is to see how high cash rents and low interest rates affect this election.

For 2012, an estate can be worth $5.12 million and pay no federal estate tax.  The estate can elect to use special use valuation on up to $1.040 million of value.

The IRS issues each year a list of the interest rates charged by the appropriate Farm Credit System bank for each region of the country.  For example, AgriBank, FCB covers most of the Midwest states such as Iowa, Minnesota, Nebraska, Missouri, etc.  The interest rate to be used for 2010 was 6.41% and for 201a, the rate was 6.12%.  The 2012 rates will most likely be issued in a couple of months and I would expect these rates to be at least 50 basis points lower and perhaps even lower.

Let's assume we have a farmer living in Iowa whose only asset is 640 acres of good Iowa farmground that is currently worth exactly $6,160,000 ($9,625 per acre) if it was sold on the open market.  The current federal estate tax for this property passing to his son who has farmed the property for many years would be $364,000.  However, the estate could elect to reduce the value of the property by taking the comparable net cash rent for similar property, reducing this rent by any applicable property taxes and then dividing by the interest charged of 6.12% (using the 2011 rates).  To get the value down to exactly $5.12 million, which is the amount where there is no federal estate tax due, would require a net cash rental rate of $489.60 per acre.

It is likely even with the rise in cash rental rates for 2012, the estate could make the argument that most cash rents, even for good Iowa farmland, are less than $490 per acre, net of property taxes.

However, if the 2012 interest rate comes in at 5.62%, this lowers the cash rental rate hurdle to $450 per acre and if the rate is 5.12%, it is about $410 per acre.  Most of the cash rents that I am hearing about for very good Iowa farmland are approaching, if not exceeding $450 per acre.  Therefore, instead of being able to fully reduce the farmland value by the full $1.04 million available, the estate may only get half that amount and still owe perhaps $200,000 in federal  estate taxes.

In years past, it was usually easier to reduce the estate using special use valuation than it may now be with low interest rates and high cash rents.

Watch Out for State Taxes

Jun 14, 2012

In my home state of Washington, we have an excise tax for any real estate sales that take place during the year. This tax is usually close to a 2% rate on the gross sales price. For a sale of $1 million of real estate, your excise tax liability is about $20,000.

Many taxpayers had created partnerships to own real estate, and this got even more common when limited liability companies came into existence about 30 years ago. Many of these partnerships and LLCs had 50/50 partners. After a few years of ownership, it was very common for one partner to buy out the other partner. Most taxpayers would feel that this should not trigger an excise tax, but the State of Washington has a rule that says if a controlling interest in an LLC or partnership is transferred in any one-year period, the excise tax is triggered based upon the fair market value of all of the underlying assets.

The state's definition of a controlling interest is a sale of 50% or more. When I look in a dictionary, I do not find 50% considered to be controlling, but for the State of Washington, it is.  This can lead to unexpected, costly consequences for our taxpayers.

Let's consider a 50/50 LLC with one piece of real estate with a gross value of $2 million and debt owed of $1,950,000. One member buys the other member out for $25,000 and reports this on his tax return. He does not file any excise tax return with the state. Suddenly, he gets a nice letter from the Department of Revenue telling him the LLC owes excise tax of about $36,000 plus interest and penalties.

The bottom line is that when you consider structuring transactions for federal and state income tax purposes, you always need to watch out for other state excise, sales or property tax issues.  Many times, these taxes can be substantially higher than income taxes.

Food for Thought on Ag Yields

Jun 11, 2012

We had a reader response to our last post on the U.S. rarely being No. 1 in yields that I thought I would share with you:

"Really interesting post. Something that jumped out at me was the need to keep in mind the spatial context of these numbers. Let's take Chile and Jordan corn production, for example. According to the 2003 FAO data, Jordan only raised 430 hectares (1,062 acres). Chile has a great irrigated growing environment, but you have to keep scale in mind. According to the FAO, Chile produces about 1.19 million metric tons of corn (about 47.6 million bushels). In the U.S., we have COUNTIES that produce almost that much corn (Yuma County, Colo., produces about 42 million bushels per year). Thanks for the article and the food for thought."

As the reader mentioned, the scale of corn production for these two countries is much lower than the U.S. production or even the production from one county in Colorado, Iowa or other corn producing states. 

I think the key point for me is that as the demand for acres continues to increase, a farmer may want to consider investing more funds in (1) irrigation systems, (2) highly intensive crop management practices, or (3) other methods of substantially increasing yields. This may result in a much higher return to the farmer than simply chasing the neighbor's quarter section at $500 cash rent.

For example, in my home state of Washington, many areas near where I live had normal wheat yields of 20-30 bu. or in many cases even less. Starting about 60 years ago, many of these acres were able to be irrigated, and it is now very common for wheat yields on this same ground to be in the 175+ bu. per acre area and, in many cases, pushing over 200 bu. per acre. Corn yields are quoted in tons, not bushels, and many farmers continue to put semi-arid land into production each year and turn desert wasteland into $10,000+ per acre value.

U.S. Is Rarely No. 1 in Yields

Jun 07, 2012

I think it is fairly common for us as Americans to assume that our agricultural production leads the world in yields. But when you review the average yields by variety, in many cases the U.S. does not even make the top 5 for yield. This may be partly due to smaller countries using irrigation on all of their crops for that particular variety; but, having visited Europe a few times and viewing their agricultural production, I can vouch that many of these farmers "baby" their crops more than we do. Many of them make a living off of 100 acres instead of 1,000, so they have to maximize their yields.

For example, I pulled the top 5 yielding countries for various crops as follows:

Corn

  1. Jordan                  318 bu. per acre
  2. Chile                     191 bu. per acre
  3. New Zealand          175 bu. per acre
  4. U.S.                      159 bu. per acre
  5. Canada                  143 bu. per acre

 

Soybeans

  1. Argentina             43 bu. per acre
  2. U.S.                     41 bu. per acre
  3. Brazil                    40 bu. per acre
  4. Canada                 37 bu. per acre
  5. China                   27 bu. per acre

 

Wheat

  1. New Zealand         119 bu. per acre
  2. Zambia                 104 bu. per acre
  3. Switzerland             89 bu. per acre
  4. Chile                       88 bu. per acre
  5. Egypt                      87 bu. per acre

 

As you can see, for corn we are No. 4, for soybeans No. 2, and for wheat, we don't make the top 5. 

Many of these countries can learn from our production methods, but I think we can learn from theirs too.

Present Is Better than Future!

Jun 06, 2012

Many farmers have created limited partnerships or limited liability companies (LLC) to hold their farmland.  As part of this process, gifts are made to children and grandchildren for estate planning purposes.  For 2012, each person can give $13,000 (most likely rising to $14,000 in 2013) to as many people as they want and not have this gift counted toward their lifetime gift exemption amount (currently $5.12 million).  However, in order for this annual gift annual exclusion to count, the gift must be of a present interest, not a future interest.

A present interest is "An unrestricted right to immediate use, possession, or enjoyment of property or the income from the property".  A gift of cash, stock, land, etc. is a present interest. 

A future interest is a more technical term related to some delay in the donee being able to use the gift.  For example, if the donor retains the use of the property for ten years and then it transfers to the donee, this is considered a future interest and the donor would not be able to use their annual exclusion amount.

In a recent case of the Estate of George Wimmer, the Tax Court decided in the favor of the taxpayer regarding the gifts of limited partnership interests.  The key rulings of the case deciding the gifts to be present interests were:

  1. The partnership would generate income (it owned dividend paying stocks),
  2. Some portion of that income would flow steadily to the limited partners (the partnership had a history of distributing income to its partners), and
  3. The portion flowing to the limited partners could be readily ascertained (since the investments were in dividend paying stocks, they could readily determine the amount of income generated)

 

In applying this case to our farm clients, it is very important that any gifts of limited partnership or LLC interests be structured to meet all three tests.  If the farmland is being rented on a cash basis and there is a history of making at least annual distributions, then you should be able to use your annual gift tax exclusion.  However, if income is very sporadic and there is a history of no payments to limited partners (i.e. the general partners take all of the income to live on), then you are at a much greater risk of losing the annual exclusion and may have other tax consequences as well.

Another Large Charitable Donation Gets Thrown Out!

Jun 04, 2012

We have done a couple of posts on the requirements for reporting charitable donations, whether in cash or non-cash.  The penalty for not documenting these donations properly is, in most cases, a complete dis-allowance of the deduction.

Now, we have another Tax Court case showing the folly of a "sophisticated" taxpayer not following the instructions to the tax forms costing them a charitable deduction in excess of $4 million.  The taxpayer owned several pieces of property located in the Sacramento, CA area.  In 2003, the taxpayers created a charitable remainder trust and donated the property to the trust.

In preparing their income tax return, the taxpayer appears to have prepared the return himself and did not get a qualified appraisal for the property.  The IRS audited the return and disallowed the charitable donation claimed.  The Tax Court just ruled that the IRS was correct.

The interesting part of this case is that the IRS really did not have an argument with the valuation done by the taxpayer.  As a matter of fact, they basically conceded that the value was most likely higher than what the taxpayer claimed.

However, the taxpayer filled out the form, did not read the instructions and had his entire donation amount disallowed.  A qualified appraisal would have probably cost the taxpayer about $5-10,000  and having a CPA prepare the return another $2-5,000.  This would have allowed the donation and probably saved the taxpayer easily $2 million or more in taxes.

The income tax laws continue to get more complicated and if you have any complexity to your tax return, you must get qualified advice especially on a donation of $18.5 million of property to a CRT.

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