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July 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.

What's My Step Up

Jul 29, 2010

In my last post, I gave an update on the current estate tax law and how it my apply to farmers for 2010.  In that post, I referred to the term "Step Up" and I am using this post just to explain what the term Step Up or Step Down means.

Up until this year, when a person died, the property that passed through to their heirs received a step up or down in cost basis to the fair market value at the time of death.  When the heirs would sell the property, this is the amount they would use for their cost basis.  For example, if a farmer owned land that he paid $100,000 for and it was worth $500,000 when he died, the heirs would be able to use the $500,000 when determining their capital gain when they eventually sold the land.  Conversely, if the fair market value at death was $50,000, then that would be the value they would use.

For the last several decades, this has been rule for inheriting property and then selling it by the heirs.  Starting this year, the IRS requires to Step Down any property, but use cost only on the other property that is worth more than what was paid for it originally.  However, the executor can make an election to step up value of up to $1.3 million or an additional $3 million for a surviving spouse.  In addition, the final income tax return for the person dying will be required to fill out a schedule showing the cost basis of all assets passed on to their heirs.  This cost basis is what the heirs will have to use in computing their capital gains tax when they sell any of these inherited assets.

As you can see, although there might not be any federal estate tax, there will be extra capital gains taxes and a lot more work for the executor and their professional to do.

Estate Tax Update

Jul 27, 2010

I am currently in a financial investment conference in Chicago for a couple of days and during one of the sessions, the current estate tax situation was discussed.  There appears to be at least 6 billionaires that have died this year and under the current law, they will owe federal estate taxes, however, in most cases, they will owe state estate taxes.  Now, this appears to be a good deal, however, there is an income tax cost to not have an estate tax.

This cost relates to there being no step up in basis of the assets that are inherited by the heirs.  They can elect to step up $1.3 million in assets or an extra $3 million going to a surviving spouse.  Lets see how this might affect a farmer with a decent size estate.  Lets assume that a farmer dies with land valued at $10 million and equipment valued at $2 million.  Assume there is no other assets and the basis in these assets is only $1 million.

There will be no federal estate tax due, however, most likely about $1 million of state estate will be due.  Now lets assume the heirs elect to step up the equipment by $1.3 million and then they sell the assets in 2011.  The capital gains rate for the land including state income taxes will be about 30% so, they will owe about $2.7 million of federal and state income taxes.  On the equipment, there will be a gain of $700 thousand and assumption top bracket of about 50% for federal and state taxes will result in total taxes on this gain of about $350 thousand.

Therefore, in total, the estate and heirs have paid estate taxes of $1 million and income taxes of about $3 million for total taxes of $4 million.  Under the law in effect for 2009, there would have been estate taxes of about $4.5 million and no income taxes. 

So you can see that even there is no federal estate tax for this year, a farmer who passes away with certain tax facts can almost pay the same amount in state estate and related income taxes. 

Please make sure to review your situation with your tax advisor.

Also, these laws are most likely to change during this year or next and we will keep you posted.

 

Don't Miss a Marketing Opportunity

Jul 21, 2010

Since the June crop report came out, wheat has rallied over a $1 per bushel, corn is up about 50 cents and soybeans have rallied also.  Now, it appears that the world wheat supply is looking at drought issues around the world (except for our hemisphere it seems) and this is continuing to help wheat prices rally.

Although I am not a marketing expert, as a CPA, it is always good to review your farm budget for the year and I believe that for most of our farmers, especially wheat farmers, your estimated crop price is less than what the market it now.  Therefore, you should review with your marketing expert what options you have right now such as taking advantage of forward hedging, buying a call, etc.

I remember when I was in my teens and wheat prices had rallied about a $1,50 and I was talking with my uncle.  He had not sold any of his crop yet and the market price was very near a round number such as $6.00 a bushel.  He told me he was going to sell when it hit that number.  As you can guess, it never got to that number and he rode the price decrease all the way down to the very low of the market when he sold.

Make sure this does not happen to you this year.

S Corp versus C Corp Dividends

Jul 19, 2010

In my post about large tax increases coming for dividends, there were several replies on our blog regarding how this affects S corporation dividends and other related issues.

I thought I would use this post to give our farmers a quick update on how income is taxed for C corporations and S corporations.

First, a C corporation simply refers in the part of the Internal Revenue Code dealing with corporate taxation (C).  Almost all farm corporations are C corporations unless they elect to be taxed as an S corporation (to be discussed below).

A C corporation will each year compute it taxable income and then pay an income tax based upon the bottom line.  If the taxable income is less than $50,000 the tax rate is 15%, however, as the income increases over this amount, the tax rates increase substantially and for income between $100,000 and $335,000, the rate is 39% plus whatever the state income tax rate will be.

After this income is computed and the corporate tax paid, the shareholder will be subject to a separate tax when this income is distributed to the shareholder as a dividend.  Right now, this rate is 15%, however, starting next year as discussed in the post, the rate will skyrocket to close to 40% or and starting in 2013, the rate may exceed 40% due to the new Medicare surtax on investment income.

Now, if the farmer would like to stop this so-called double tax, they can elect for the corporation to be taxed as an S corporation (again this is the section in the Internal Revenue Code dealing with these types of corporations, that is why it is called an S corporation).  This election allows the corporation to pay no corporate tax and have all of the income flow through to the shareholders who then pay the tax at their normal tax rates.  This means that when the corporation pays a dividend to the shareholders, there is no additional tax since the tax has already been paid on the income.

Why would a farmer ever want to be a C corporation if there is this double tax?  There are many cases where a farmer would want to be a C corporation.  For example, assume the farm only earns about $75,000 a year.  Under this scenario, the farmer using proper tax planning would most likely not pay any tax at all if they have two or more minor children, whereas, being taxed as an S corporation could result in several thousand dollars of tax (see previous posts on this).

The bottom line is that you need to review your income tax situation both for the current year and for future years and determine which corporation works best for you.

Health Care Credit Limits Posted by IRS

Jul 16, 2010

The large health care act passed earlier this year had an up to 35% credit available to farmers who paid for health insurance for their employees. The credit is based upon the percentage amount of health insurance that a farmer pays times 35%. As long as you pay at least 50% of the premiums for your employees, the credit is based upon the amount paid times 35%.

However, there is a cap on how much premium you can use. This cap is based upon the average premium for small group markets for each state. The IRS just published revenue ruling 2010-13, which outlines what this cap amount is for each state. The cap is based either on employee-only coverage or family coverage. I will give you an example of how this cap might work for you as a farmer:

Suppose you have two employees. One is single and one is married with kids. Assume that you pay 80% of the medical insurance for each employee. Also, assume you are a farmer in Iowa.

Let's calculate the maximum amount of the credit by assumimg that the cost of this premium is $500 per month for the employee and $950 per month for the family. The credit that you could take is 80% of the premium times 35% for the year. This would equal $500 times 12 times 0.8 times 0.35, or $1,680 for the single employee, and $950 times 12 times 0.8 times 0.35, or $3,192 for the family employee, for a total credit of $4,872.

Now we need to determine how much of this credit is allowed by comparing it to the small group market tables from the IRS. For the single employee, the maximum credit allowed for Iowa for a year is $4,652. Since the farmer paid only 80% of the premium, this would equal a total allowed amount of $3,721.60 times 35%, or $1,302.56 maximum credit allowed for a single employee. For the family employee, the state of Iowa maximum annual amount is $10,503 times 80% times 35%, or $2,940.84. These two amounts added together result in a maximum credit allowed of $4,243.40. 

Our original calculation resulted in a credit of $4,872. The IRS allows only $4,243.40 based upon the small group market tables, so the actual credit you would use on your tax return is $4,243.40.

A quick way of determining whether you need to worry about this is to look at your premium on a monthly basis and compare it to the table amount (after dividing by 12 to make a monthly comparison). If your premium is less than the table amount, you can ignore it on the tax return. However, if your premium is greater than the table amount, you will need to limit your credit based on this calculation.

Dividend Tax Rates are About to Skyrocket

Jul 10, 2010

Congress back in 2001 dropped the maximum tax rate on dividends received by a taxpayer from 39.6% to 15% (plus any applicable state income taxes).  But under the so-called Sunset Rule, these special low rates expire at the end of 2010.  Beginning in 2011, the top rate is expected to go back to 39.6% and beginning in 2013, the effective top rate will be 43.4% after taking in account the new Medicare surtax of 3.8%.

What this means to a farmer who has a C corporation that is in the top tax bracket both at the corporate level and at the individual level is as follows:

  • For 2010, your maximum combined corporate and individual income tax rate will be 44.75%
  • For 2011 and 2012, your maximum combined rate will increase to 60.74%
  • For 2013 and thereafter, your maximum combined rate will be a whopping 63.21%.  This represents a huge 41% increase since 2010.

A tax planning tip is to review your current retained earnings and see how much you should drop out to you in the form of dividends.  If the corporation needs the working capital, you can always loan it back to it at very cheap interest rates.

Minnesota Farms See 63% Drop in Farm Income in 2009

Jul 07, 2010

Of the 2,401 Minnesota farms included in the "FINBIN" survey for 2009, the median farm saw a 63% decrease in net income from $91,242 to $33,417. Each year, the Center for Farm Financial Management performs a survey of Minnesota farmers. Their response for 2009 represented about 3% of overall farms and about 10% of the farms with total sales over $100,000.

A summary of the results for 2009 show the following:

  • Median farm income peaked in 2007 at about $105,000 and have declined in two years to about $33,000. The 2009 numbers are also the worst net income for any year in this decade other than 2001, when the median net income was about $24,000.
  • Incomes were down substantially for virtually every type and size of farm.
  • Livestock farms of all types, on average, did not provide enough income to support family living expenses.
  • While crop farms were more profitable than livestock farms, the median earnings of crop farms dropped 55% to about $60,000.
  • Dairy farm profits were down substantially, falling to an average of about $5,000 per farm. The average price for milk dropped from about $19 to $13 in one year.
  • Hog farms eked out a small profit as their income dropped about 87%.
  • The average return on assets dropped from 10.5% in 2008 to 3.1% in 2009.
  • The average farm's net worth increased by about $60,000. However, almost all of this increase was due to increasing land prices and not earned net worth growth.
  • The average farm spent $52,000 on living expenses and needed to generate $72,000 from farm and nonfarm income to cover family living, income taxes and other ongoing nonfarm expenses.

Challenges Facing Conservation Reserve Program

Jul 01, 2010

With the 2008 farm act, substantial changes were made to the USDA Conservation Reserve Program (CRP). The major change was reducing the maximum enrollment acreage from about 37 million acres to 32 million acres, which is about a 14% reduction in maximum acres. Also during this period, a substantial increase in commodity prices took place, which has caused CRP rent prices to increase dramatically in some areas.

The June 2010 issue of Amber Waves has a very good article on the challenges facing the CRP.  A brief history shows that the program began in 1985 and 1986 and the primary goal was to retire highly erodible farmland from production for a 10- to 15-year term. Enrollment grew quickly, reaching about 33 million acres by 1990. After the initial contracts were issued, program goals were modified to include water quality and wildlife habitat improvements in addition to reduced soil erosion. To capture these multiple benefits, starting in 1990, program administrators used an Environmental Benefits Index (EBI) to rank competing offers received during periodic "general sign-ups." The EBI computes a score using a formula that weighs such factors as soil erodibility, location within a priority zone, the proposed conservation practice and the requested rental rate -- with offers accepted only if an EBI score exceeds a cutoff value.

1n 1996, a continuous CRP was added to enroll parcels of land with high enviromental benefits outside of the EBI ranking process.

Between 1990 and 2008, CRP enrollment fluctuated around 33 million acres, with a high of 36.8 million in 2007. As of February 2010, the total acres in CRP are about 31.2 million. This includes about 4.5 million acres of continuous sign-up acres.

With the new farm bill coming up in the near future, it will be interesting to see what changes will be made to the program.

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