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August 2013 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 Tax on Selling Equipment

Aug 28, 2013

We had a reader ask the following question:

"If I sell my personal property that is all depreciated out.What will my tax be?"

As with most tax questions, the answer is "It depends".

If you sell equipment for a sales price less than the original cost, then this gain is considered to be a Section 1245 gain and is tax at ordinary rates. Therefore, if you are in a 25% tax bracket, your tax will be 25% of the sales price (since the equipment is fully depreciated) plus any state income tax.

If you sell the equipment for more than what you bought it for, then the excess amount is considered a Section 1231 gain and this gain will be taxed at the favorable capital gains tax rate (unless you have a net 5 year carryover of Section 1231 losses). However, in most states this will be taxed their regular state rates.

As an example, on the farm I grew up on, my father purchased a new Caterpillar D5b tractor in 1973 for $32,000. He then sold this tractor in 1982 for $39,000 (yes, used equipment can increase in value). The $32,000 would be taxed at their regular tax rate, while the extra $7,000 of gain would be taxed most likely at 15%. If my parents had been in the highest tax bracket, then this part of the gain would be at 20%. The 3.8% net investment income tax would not apply since this was a gain from the sale of business equipment.

As usual, what sometimes seems like a simple question can lead to a more complex answer.

Installment Sale Update

Aug 26, 2013

We have gotten some feedback to our installment sale post of yesterday and this post will clarify some of those questions and feedback.

First, if the land being sold is an active part of a schedule F farm business, then it should not be subject to the 3.8% net investment income tax as shown in my example. However, most of the farm operations that we are involved with now have the land in a partnership (LLC or LLP) and cash rent the land back to the active farm business. In other cases, the spouse owns the land and cash rents to the farmer spouse. In these cases, the sale of farm land by the partnership under the IRS Proposed Regulations would most likely be subject to the 3.8% tax.

Therefore, if the sale is made by an active Schedule F farmer with the land titled in their sole ownership, then no 3.8% tax is owed, otherwise the 3.8% is probably owed.

Also, if the farm land includes the sale of grain bins, fencing, roads, etc. that are subject to depreciation recapture, all of this income must be reported in the year of sale. Therefore, in these situations, you would want to get enough cash to cover the taxes owed on this gain and it does not receive the special capital gains tax rate.

As pointed out many times, if you are anticipating selling farm land, make sure to discuss it with your tax advisor before the sale (we have too many discussions after the sale when it is too late to fix problems).

Section 179 Cystal Ball

Aug 26, 2013

We had a reader ask the following question:

"What is the Section 179 amount for 2013 and what will the amount be for 2014?"

The first part of the question is easy to answer. For 2013, Section 179 is $500,000 and it starts to phase-out as your equipment purchases exceed $2 million. Section 179 applies to all farm property with a depreciable life of 15 years or less which includes almost all farm property except for farm buildings. Section 179 can be used on new and used property, however, it is only available on the boot portion of property acquired in a trade.

For 2014, it may get a little more complicated. Right now, Section 179 is $25,000 for 2014. There have been proposals by President Obama to raise this to possibly $1 million and perhaps even make that a permanent number. However, as of yet, and knowing how dysfunctional the whole process in Washington DC is right now, it may remain at the $25,000 until after next year's election.

On a similar subject, 50% bonus depreciation on all new farm property is available for 2013, but is scheduled to phase-out for 2014. Again, this may change and we will keep you posted.

The Power of Installment Sales

Aug 25, 2013

We had a reader ask the following question:

"I plan to sell some land this year. Will my tax liability be less if I take payments from the buyer over several years?"

Before answering this question, lets review how an installment sale works. Instead of owing all of the tax in the year of sale, the tax laws allow you to spread your gain over the installment period and report the gain as principal is collected. Interest income is always reported as received. The tax owed is based upon your total principal received during the year times the capital gains tax rate in effect.

For example, assume a married farmer has a cost basis in his land of $100,000 and sells it for $500,000. His gain is $400,000 or 80% of the total sales price. If he collects an $100,000 down payment in year 1, he will be tax on $80,000 and assuming a 15% long-term capital gains tax bracket, he will owe $12,000.

Before 2013 this answer was much simpler. With long-term capital gains rates capped at 15%, most of the savings from using an installment sale to report a long-term capital gain was spreading the income over several years and deferring the tax owed. In most cases, it did not reduce the tax, but simply extended the period to pay.

However, in 2013, we now have the introduction of the 3.8% net investment income tax and the higher 20% long-term capital gains tax for higher income taxpayers.

Assuming our farmer had other ordinary farm income of $150,000, his total capital gains tax bill if sold for cash would be 15% on the first $100,000 of gain, 18.8% on the next $200,000 of gain and finally 23.8% on the last $100,000 of gain for total tax owed of $76,400 (the actual tax would be slightly higher due to phaseout of itemized deductions and exemptions). However, if he spreads the gain over the next ten years and keeps his net gain in the 15% bracket (staying under $250,000 of adjusted gross income), the total tax owed on the gain would only be $60,000 for a net tax savings of $16,400. Plus, the farmer may have received an interest rate on the installment note greater than current interest rates.

Therefore, for 2013 and beyond, the use of an installment contract to sell farm land may be even more beneficial than it was in the past. If you are considering the sale of farm land, make sure to review your options with your tax advisor.

First DAy of the Midwest Crop Tour

Aug 19, 2013

We left Columbus, Ohio this morning at 7 am and headed west. It was tough going the first couple of hours with the suburbs and humidity cloud to get any samples in, but we finally got some samples. Our lowest of the day was 53 bushels in Drake County but as usual on the crop tour, our best sample at 218 was in Mercer County, our next stop. Our overall yield for Ohio was about 145 bushels per acre which probably put us at the lowest average for the day.

Pro Farmer called the Ohio crop at 171.64 based upon all of the data collected. The number of ears, length and rows were all up substantially from last year (which is expected) and the final number is very close to the USDA number from last Monday. My observations are that unless this region gets rain soon, it will not fill all the way to this number. The rain is especially needed for beans. We had a several fields with large cracks in the dirt and one crack was about an inch wide and at least 8 inches deep.

The soybeans looked OK, with Pro Farmer calling the average pod count at 1284 for Ohio. Our average was 1289 so we tracked that fairly closely.

Our counts for Indiana for District 6 were about 153 bushels per acre and bean counts were in the 1,178 range.

On the Western Leg, the scouts came up with an average of about 162 bushels per acre for South Dakota which would be a record of close to it, however, the maturity level is behind and it will need help to get to that final number. Their bean count was also up from last year.

Tomorrow, we head due west towards Bloomington, Illinois. I think my route is fairly direct, but many scouts will put on close to 400 miles before the day is over. Following the crop tour on Twitter is very easy if you follow the conversation at #PFTour13.

More tomorrow.

The Start of The Midwest Crop Tour

Aug 18, 2013

We are at Columbus, Ohio for the start of the Midwest Crop Tour. Tonight, all of the scouts have a meeting to go over the ground rules for the tour. On the Eastern Leg will be 11 routes that cover the area from Columbus to Southern Minnesota. The Western Leg will cover Eastern South Dakota through Eastern Nebraska, Western Iowa and then Southern Minnesota.

The corn data is based upon sampling 60 feet of corn out of a field past the end rows. We then consistently pull the 5th, 8th and the 11th ear. You take the average number of ears in 30 feet (total of 60 feet divided by 2) times the average length of the three ears times the average rows around the ear and then divide by the row spacing.

For example, assume that you end up with 100 ears of corn in the 60 feet counted. The three ears pulled are 6", 7" and 8" long. This averages to 7". Each ear is 16 rows around so that average is 16. The corn is 30" spacing. Therefore, the estimated yield is 50 times 7 times 16 divided by 30 or about 187 bushels per acre.

We also count soybeans at the same time (if possible). We take the total number of plants in 3 feet of row. We then pull 3 plants and get the average number of pods on each plant (1/4" minimum length). We take that average number of pods times the number of plants times 36 divided by the width of the row. For example, assume there are 14 plants in three feet in 15" spaced soybeans and the three plants averaged 60 pods. 60 times 14 times 36 divided by 15 equals 2,106 estimated pods in a 3 foot square plot. This number is published, but no estimated yield is made since the tour is too early for an accurate estimate of the bean crop.

We will be posting to the blog at least once per day and if I can get my IPad to cooperate I will post during the tour each day.

I am also posting directly on Twitter @farmcpa. I did do multiple tweets today on Twitter and had one small embarrassing issue with the Twitter spell checker. For some reason when I tried to spell longer it came out lingerie.

We will keep you posted on our observations.

California is Out of Control

Aug 16, 2013

Since I practice in the state of Washington, I end up doing a fair amount of California business and personal tax returns. This is one of my least favorite states to deal with and a recent court case winding its way through the system highlights this even more.

In Swart Enterprises, Inc. v. Franchise Tax Board, the taxpayer was an Iowa corporation with a farming activities in Kansas and Nebraska. They also had various passive business investments including an .02% interest in a California LLC (Cypress) that acquired, held, leased and disposed of capital equipment in various states. This LLC had 435 members of which 384 members were out-of-state.

The Franchise Tax Board asserted that Swart had enough business activity through their .02% interest in the Cypress LLC to require the filing of a California LLC tax return. Normally LLC's filed as a partnership do not owe any state tax, however, California charges $800 simply for the privilege of filing a return. In addition, based upon the gross revenue of the LLC an additional fee is owed. Since Swart was a corporation, that particular fee would not apply, but they would owe the $800 filing fee plus interest and penalties plus paying a person to prepare the tax return.

This case is winding its way through the Court System and I hope that the taxpayers win. $800 may not be a lot of money, however, lets assume that Cypress, LLC generated income of $1,000,000 and based on the ownership held by Swart, this would generate $200 of income. Therefore, California is requiring them to pay $800 on $200 of income which is an effective tax rate of 400%.

If California is successful in winning this suit, they have another 383 out-of-state members that they can go after at $800 each per year or about $306,400 of additional filing fees plus interest plus penalties just for Cypress and I can guarantee that they will review every LLC filed in their state and start sending out notices even if you own .02% or less of the LLC.

Therefore, if you are farming operation in the Midwest, but you own some small passive LLC investment that is located in California, you may want to consider selling it before you get a notice from the Franchise Tax Board.

Mid West Crop Tour

Aug 16, 2013

Just letting everyone know that I am leaving bright and early tomorrow morning to fly to Cedar Rapids, Iowa. Chris Barron is picking me up at the airport and we are then headed to Columbus, Ohio. We will spend the night in Bloomington, Illinois (most likely) and then meet up with about 100 scouts in Columbus, Ohio Sunday night.

At that meeting, Brian Grete from Pro Farmer will fill everyone in on how the process works and then hand out route assignments. This is my fourth year of doing the tour (this is my only summer vacation so to speak) and my second year on the Eastern leg. The first two years I did the Western leg through South Dakota, Nebraska, Western Iowa and Southern Minnesota. The Eastern leg covers Ohio, Indiana, Illinois, Eastern Iowa, and Southern Minnesota. We will meet up with the Western group in Rochester, Minnesota this year.

In order to have an effective crop tour, Pro Farmer attempts to do the same routes each year and gather data based on these routes. We will not be taking samples from the same fields (unless by chance) and each night we hand in our samples from the corn and bean fields. Usually each route will have between 15-20 samples and each county will have at least one sample. The Pro Farmer team then takes that data, analyzes it, and then will publish their projection for each state as we end the tour for that state.

For example, the first day (Monday), they will issue an estimated yield for Ohio and South Dakota since we have finished the tour in those states. Nebraska and Indiana will be issued on Tuesday. Illinois will be issued on Wednesday and Iowa and Minnesota will be issued on the final day of the tour. They may issue Western Iowa on Wednesday.

The crop tour usually results in fairly accurate numbers. I think the biggest variance was for the 2011 crop which was a result of a big heat wave hitting the crop right after we did the tour. That resulted in yields dropping off a lot.

As you can probably tell I really enjoy doing the crop tour (although it is hard work getting in and out of 20 fields and driving up to 350 miles in a day for four straight days). My goal is take lots of photos on this tour and post them to the blog through out the day.

I will also be posting tweets on Twitter at #farmcpa. The Twitter feed for the tour is at #pftour13.

New Website for Healthcare Provisions

Aug 16, 2013

The IRS has just released a new website that recaps and provides information on most of the Health Care Provisions of ObamaCare. Although we sometimes have issues with the IRS as preparers and farmers, I must admit that their website is one of the better sites on the internet. There is a lot of information provided and it is fairly easy to find what you want unlike trying to call them on the phone (I think my average wait for getting someone on the phone is approaching over an hour).

I have not spent a lot of time on their new Health Care site, but it appears to have a lot of good information on these provisions and if you have any questions regarding the new law, this would not be a bad place to start.

How to Blow a 1031 Exchange

Aug 15, 2013

Recently, I had a taxpayer call me about the sale of some farm land. The taxpayer had sold 80 acres for $960,000 that they had inherited from his mother about 20 years ago. The tax basis in the property was about $150,000 so they were facing an $800,000 long-term capital gain which would cost them about $175,000 in federal and state income taxes.

The taxpayer indicated they had rolled the gain into other real estate costing about a $1 million and wondered how the rollover gain would affect the basis of their new real estate investment. Many of you probably can guess what my next question was. "Did you receive the cash and then buy the real estate?" To which, the taxpayer said "Yes, we received the cash, but we bought the real estate within 180 days of selling the land".

A Section 1031 tax-deferred exchange is a very valuable tax tool to help reduce your income taxes when selling farm land or other investment properties. However, there are many rules that must be followed and if you fail one of these rules, it can blow the whole exchange. In order for an exchange to be valid, the cash must from the sale must not be in the hands of the seller. Even if you reinvest the cash into other real estate within the 180 day window, the fact that you had the cash or had access to the cash makes the whole sale taxable.

In order to prevent this from happening, you must use some type of facilitator to handle the sale and the related purchase of your replacement real estate. They will step into the "shoes" of the exchanger and hold the funds until the new real estate is bought. Without this facilitator, most exchanges would be taxable (there are cases of where you can do a direct exchange such as farm equipment with a dealer, however, most real estate exchanges require a facilitator).

It was not fun for me to relay this information to the taxpayer, but this could have been prevented by them calling their tax advisor before going through with the sale. If you are anticipating a sale of real estate and want to defer the gain, always discuss this with your tax advisor before closing the sale. You can usually sign the purchase and sales agreement, but do not close it without getting a facilitator involved.

Update on the New Farm Bill

Aug 13, 2013

Mark Reisinger, the Global Grain Trade lead gave an update on the new farm bill this morning at the NextGen conference.

With the House failing to pass a Farm Bill that included the nutrition program, we now have a Senate/House sub-committee working on a new Farm Bill.

The Senate portion offers two programs based on an adverse price movement and a revenue based risk coverage (ARC). This is designed to cover about another 10% of the risk that is not covered by normal crop insurance (78%-88%). Can be for individual farm or county based.

The House version either has a Price Loss Coverage (PLC) or a Revenue Loss Coverage (RLC). Unlike the Senate where both programs are available to the farmer, the House version is either/or. The Price Loss Coverage is offered only for certain commodities and for certain crops such as peanuts and rice, the price levels are actually higher than the current market price for that commodity. This will most likely provide an incentive for growing more of these crops which will tend to drop the market price even lower. This may lead to another World Trade Organization dispute (similar to the Brazil Cotton payments being made by the USDA).

Assuming 2014 prices, corn farmers would get a $1 per acre, soybean farmers get zero and peanut growers get $105 per acre. This is not based on any historical price pattern, but is based on the growers associations lobbying the House for these price levels. These acres would be based on intended acres not historical. This will distort prices and most likely drive some corn and bean acres to peanut acres in the South. Barley and rice acres would also most likely increase under this program.

Under either the House or Senate version of price supports, only Barley, Peanuts and Rice would receive any material payments.

The Revenue Loss Coverage drops the 10% band to the 75%-85% range. It is only available for the county, not the individual farm.

The scoring for the AMP (Senate) is $600 million per year and the ARC (Senate) is about $5 billion per year. The House total would be about $5 billion per year with most of it being the PLC since the assumption is that most will opt into the Price Support Program.

Don't Forget Your Retirement (Plan)!

Aug 08, 2013

I get the following question at least three or four times a year from our clients:

"I know my income is too high to contribute to an IRA, what other options are there?"

When Congress put in the income limitations on IRA several years ago, there arose a misconception regarding the limit. Many people, including several in the financial advisory business, assumed that if your income was too high you could not contribute to an IRA. The actual law states you can always contribute to an IRA (assuming you have earned income at least equal to the IRA contribution), it is the tax deduction that may be limited. If you are not covered by a retirement plan, you can always deduct an IRA. If you are covered by a retirement plan, then as your income goes above a threshold amount ($95-$115,000 MFJ and $59-$69,000 Single), the deduction is reduced until it is fully phased out.

However, let me reinforce, you can always contribute to the IRA. For 2013, the limits are $5,500 per person plus an additional $1,000 if you are age 50 and over. Roth limitations are similar, however, the income levels before you are unable to make a contribution rise to $178-$188,000 for married couples and $112-$127,000 for singles. These amounts are a combined IRA/Roth limit. You can allocate the totals however you want, but cannot exceed the overall limit. For example, you could put $3,000 into an IRA and $2,500 into a ROTH. However, if you put $3,000 into each, you would be $500 over the limit.

For many of our farm clients, they have faithfully contributed to an IRA each year and with the additional income would like to put more into other retirement plans. There are many types of plans available such as a Keogh, SIMPLE, SIMPLE 401, profit-sharing plans, etc.

For those farmers who would like to contribute up to about $50,000 and are taking fairly small salaries out of their corporation, the use of a 401k plan can make a lot of sense. With this type of plan, each participant can individual set aside up to $17,500 or $23,000 if age 50 and over plus the corporation can contribute and deduct 25% of the participants salary.

As an example, assume Bean corporation has two employees. Farmer Bean normally takes a salary of $50,000 and pays his spouse $20,000 for her bookkeeping and other services. Both are over age 50. By changing the salary levels to $45,000 and $25,000 respectively, they can obtain a net deduction (both at the corporate and individual level) of:

  • Farmer Bean 401k deferral - $23,000
  • Mama Bean 401k deferral - $23,000
  • 25% of $70,000 of salary of $17,500
  • Total deduction of $63,500

 

The deferral reduces the amount of wages that Farmer and Mama Bean will report on their form 1040. The $17,500 paid by the corporation is deducted on the corporation tax return.

If the corporation has employees, then the corporation would be required to match the percentage that the company puts in the Farmer and Mama Bean. In this case, the corporation may elect to reduce the amount they place into the plan, although an effective tool to help motivate and retain good farm employees is to offer a retirement plan. Many farmers view this as investment in employee relations, not a cost.

There are many other examples of how these plans may work, but we wanted to make sure you understand you can always contribute to an IRA even if covered by a retirement plan and show you an option for additional retirement savings.

IRS Releases Draft Form For New Net Investment Income Tax

Aug 07, 2013

The IRS has finally released a draft of the new form 8960 to report the 3.8% net investment income tax for income in excess of the threshold amounts. As previously discussed in several posts, the 3.8% tax applies to the lesser of (1) your net investment income including cash rents or the amount in excess of $200/250,000 (single/MFJ).

The draft form is based on the proposed regulations that the IRS released last year, however, these are not yet final and the IRS did not issue any instructions for the new form.

There are three parts to the form:

  • Part 1 calculates the amount of investment income. It takes certain lines directly from form 1040 or form 1041, which is straight-forward, however, it then requires you to make certain adjustments based on whether some or all of this income is actually investment income or not. (13 lines in total)
  • Part 2 calculates the amount of allowable itemized deductions that may be used to offset investment income in part 1. The three categories are (1) investment interest, (2) state income taxes, and (3) miscellaneous itemized deductions. Of course, it is not just this simple, since there is an additional line for "additional modifications". (6 lines)
  • Part 3 then is the calculation of the tax owed (if any). (14 lines).

 

In total, there are 33 lines that you must fill out in order to calculate the tax. If you normally prepare your own tax return and your gross income exceeds $250,000, we would highly recommend having a qualified tax advisor review or prepare this form. There is always discussion about simplifying the tax code, but as usual, the actual result is more complexity each year and this form is a prime example.

Is Peak Corn Over (for now)?

Aug 05, 2013

A few years ago, the term Peak Oil was in the media. This term represented the notion that the production of oil worldwide had peaked and we would be showing lower and lower production levels each year. With the discovery of fracking of shale oil formations, this term is not used much lately.

My question is have we hit Peak Corn (prices) and how long before they recover. I reviewed the December corn chart and noticed the following highs and lows by year (rounded to the nearest quarter):

  • 2009 - Low $3.00 - High $4.50
  • 2010 - Low $3.25 - High $6.75
  • 2011 - Low $5.75 - High $8.00
  • 2012 - Low $5.50 - High $8.50
  • 2013 - Low $4.50 - High $7.50

As you can see 2009 represented the low of this contract. That was a record year for corn production (per acre averages) and exceeded trend line by several bushels. From 2010 to 2012, the corn crop did not exceed trend line and with last year's drought, we had near record corn prices. If good weather continues and we get a 2013 crop that nears its trendline with our near record production, will we see prices near the 2009 levels leading into 2014. The ethanol mandate for 2014 is higher than 2009, but we are also presented with overseas demand destruction and additional competition from South America and the FSU countries.

China also appears to be slowing down and their appetite for additional grain purchased may be waning. We all know what the rumor of China selling domestic soybeans did to corn and bean basis about two weeks ago.

All in all, it appears that the recent Peak Corn days are over, but what does this mean to your operation. Have you done a margin analysis to determine how $4 corn (or even lower) will affect your net profit for 2014. For 2013, most farmers have locked in an average price of at least $4.80 assuming 85% crop insurance coverage, however, if the spring price for next year is $4 or lower, can you still make a profit or will your working capital be negatively impacted. Did you build up a large enough cushion in the good times of the last three years to cover a possible large deficit in 2014.

We are not saying that low prices are here forever, but as the above chart shows, $3.25 corn traded hands only three years ago. Will you have $3 corn for 2014.

If so, are you ready for it?!

Hedge Accounting Update

Aug 01, 2013

The last presentation at FFSC was done by Todd Doehring of Centrec and myself on the proposed guidelines for hedge accounting.

For tax purposes, a valid hedge is usually accounted for on a strictly realized basis, i.e., the futures or options on futures is not recognized in income until the hedge is closed out. For example, if a corn farmer shorts March 2014 corn on December 1, 2013 at $6 and the price closes at $6.50 on December 31, 2013, the farmer has an unrealized loss of 50 cents which is not recognzied for tax purposes. If the farmer closes the short on February 15 at $5.50, this 50 cent gain is recognized on that date.

For accounting purposes, there are two types of hedges:

  • Fair Value Hedge - This is a hedge of inventory owned by the farmer. For a corn and bean farmer, any crop that has been harvested and placed into storage would qualify for a fair value hedge.
  • Cash Flow Hedge - For farmers, this is a hedge of growing crops or raised livestock. It would also cover feed to be purchased to be fed to livestock.

 

The accounting treatment for each of these hedges are basically the same. On a daily basis (or whenever the farmer issues a financial statement), the hedge is marked-to-market and any resulting gain or loss is recognized. The difference is where it is placed on the income statement.

For all fair value hedges, the gain or loss flows directly into the income statement. For cash flow hedges, these gains or losses are reported as part of "other comprehensive income". This statement primarily reflects changes in valuation equity.

However, the Council has also proposed an alternative method which allows all hedges to simply run through the income statement.

The key difference between Tax and GAAP is that GAAP requires a mark-to-market valuation on all hedges while the tax laws allow you to wait until you close out the transaction to report the gain or loss.

The Council has spent many years on getting these guidelines finalized and the hedge accounting guidelines should be issued in 2014.

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